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The Franchise Contract: Understanding the Personal Guaranty

by Ed Teixeira

One of the most important provisions of a franchise agreement is the personal guaranty. It’s important for prospective franchisees to fully understand the reason why franchisors require this covenant and what the implications are in the event the franchisee has problems. When performing franchisor due diligence, keep this factor in mind.

Virtually every franchisor requires that its franchisees be individually responsible for and guarantee all contractual commitments, including the financial obligations, made by 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, almost always require the personal guarantee of the franchise owner.

A personal guaranty provides the franchisor, with additional security in the form of the assets of the guarantor, the franchisee. Otherwise, the franchisor could be chasing corporate entities with virtually no assets.

Most personal guaranty provisions in the franchise agreement enable the franchisor to immediately proceed against the individual guarantor (franchisee) rather than the corporation operating the franchise. This is because the individual franchisee is usually required to waive the right to require the franchisor to proceed first against the franchisee's corporate entity.

The personal guaranty provision is contained in the Franchise Agreement and will include an exhibit of the agreement the individual must sign.

Most franchisors require that the spouse of the individual franchisee execute the guaranty obligation. This allows the franchisor to pursue those assets held jointly in the marriage, such as bank accounts, investments, personal property and real estate.

Since franchises are typically granted to individuals, who usually establish a corporation for liability or tax reasons, a franchisor views the operation of the franchise resting with an individual rather than a corporation. The franchisor uses the personal guaranty 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.

Following are some of the obligations that a personal guaranty could be used for:

Royalty payments
Advertising fund payments
Claims and lawsuits brought by third parties which the franchisee must indemnify the franchisor for
Non-compete
Confidentiality agreement
Other financial obligations

It should be understood that most franchisors will refuse to waive the requirement of a personal guaranty. However, the 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 or the franchisor may already have done this.

Suggested modifications to “soften” the personal guaranty:
Cap the financial amount under the personal guaranty.
Limit the personal guaranty 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.
There should be 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 guaranty provision in the franchise agreement is used by franchisors to protect its financial and corporate interests. Rarely, is this requirement waived. Prospective franchisees should understand the nature of this obligation when investigating a franchise opportunity, especially when performing due diligence. Finally, be confident in your decision to be a part of the franchise network.