A franchisor will commonly require a new franchisee to provide a personal guarantee. A personal guarantee makes the individual franchisee personally accountable to the terms of the franchise agreement, even if the franchisee operates the business through a separate franchisee entity (i.e. a company or trust. After the franchisee signs the guarantee, they may have a claim over the franchisee’s personal assets, such as a mortgage. For most franchisees, this is an alarming prospect. This article considers how a personal guarantee works, who needs to provide one and whether a franchisee has any alternatives.
What Am I Liable For Under a Personal Guarantee?
If you give a personal guarantee in a franchise agreement, you agree to be personally accountable for the obligations of the franchisee entity. This includes the payment of franchise fees, marketing fees, or other ongoing fees as set out in the franchise agreement. You are also guaranteeing the franchisee entity’s timely performance of obligations concerning the operation of the business.
A personal guarantee can also include that the guarantor (the franchisee) indemnifies the franchisor against all losses that result because the franchisee did not comply with the franchise agreement. These losses can go beyond the failure to pay specific fees to losses suffered more generally. For example, if the franchisee does not comply with maintenance regulations in the franchise operations manual, the franchisor could claim equipment repair or replacement costs.
A personal guarantee means that your personal assets could be sought after by the franchisor to recover these specific or general losses. As a guarantor, you agree to be personally accountable to meet the obligations, and you become liable for any failures to do so.
When can a Franchisor Invoke the Personal Guarantee?
Each guarantee will depend upon the specific scope of the clause and should be carefully considered to understand the extent of the obligations. However, personal guarantees will typically remain enforceable for as long as the franchise agreement lasts. They can even remain enforceable after termination or expiration. This is known as a continuing guarantee. The terms of the personal guarantee typically set out that the franchisor’s right to invoke the guarantee will not be affected or impaired by various events such as the liquidation or winding up of the franchisee entity.
Another common belief is that a franchisor does not have to be the first to take any action against the franchisee entity. Instead, the franchisor can immediately start legal action against the individual guarantor. This would happen, for example, if the franchisee entity does not have enough assets to pay any claim for compensation, but the individual guarantor does.
Who Should Provide a Personal Guarantee?
A franchisor will usually require an individual connected to the franchisee entity to provide a personal guarantee. For example, if the franchisee has a sole director, that person will provide the guarantee. However, what if two, three, or even more key people operate the franchisee? Should all of them provide a guarantee?
In most cases, naming more than one guarantor places a more significant burden on the business. As such, franchisees should nominate a single guarantor—the person taking the primary role in operating the franchise business. The franchisor, however, may require all franchisee entity directors to be guarantors. In any event, anyone providing a personal guarantee should seriously consider obtaining financial advice concerning personal asset protection.
Are There Any Alternatives to a Personal Guarantee?
Even though franchisors widely require a personal guarantee as a matter of practice, the law does not require it. Therefore, as a franchisee, if you do not want to offer a personal guarantee, your best strategy is to try and negotiate an alternative with the franchisor before signing the agreement. There are two main alternatives.
First, you may be able to offer an alternative guarantee. A franchisor may accept a guarantee other than one that makes you personally liable. For example, this could be a bank or a related party (a subsidiary or holding company) guarantee. Each of these alternative guarantees has both benefits and drawbacks. Therefore, you should obtain advice on what would be most suitable for your specific situation.
Secondly, you may be able to negotiate limits to the scope of the personal guarantee. Rather than removing the personal guarantee entirely, you may be able to reduce your liability for the franchisor’s losses significantly. For example, we previously mentioned two specific terms:
- that a guarantee can extend beyond the life of a franchise agreement; and
- that a franchisor can pursue the guarantor before the franchisee entity.
You can potentially negotiate both of these terms and limit them to protect your interests as a guarantor.
As a franchisee, a personal guarantee burdens you with significant personal liability. You will be potentially responsible for any losses caused by breaches of the franchise agreement. The franchisor will be able to claim your assets—such as a mortgage—to recover these losses. Therefore, you should seek legal advice about the full extent of this liability and what you can do to protect yourself. To have a franchise lawyer review your franchise agreement and guarantee, call LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.
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