Midnight move: This time into the gutter

December 12, 2008

Restaurant dispute 20081211

middlefingerThe top image is from a Canadian Press article by Nelson Wyatt called Passersby stunned as restaurant contents emptied into Montreal street.

It also hit Canada’s evening television news program, The National and resides on the CBC website where some rapidly growing comments are worth checking out.

  1. What the hell happened here?
  2. Whay would a Montreal, Canada franchisee simply rip everything out (including cash from tips!) and leave them on the street?

There is a perfectly good and rational reason for this. These were the actions of a perfectly sane, far-sighted and indeed shrewd small business investor.

  • he or she realized they were going bankrupt no matter what they did (things they can control +/- = wisdom),
  • they did what they thought was the noblest thing to do which was to deny the franchisor and bank their profits on this churn while
  • demonstrating a fine French Canadian tradition of exiting with a some self-respect intact (see bottom image).

Here is what might have happened if this is like other franchise relationship meltdowns I have seen in the last 10 years:

Normal Contract Terms:

  1. The franchisee leases the premises from the franchisor (who then leases it from the landlord). The franchisee is the subleasee: he pays the franchisor who (you hope) pays the landlord. This may or may not have been the case here. (How quickly a new body can be installed indicates a franchisor head lease position.)
  2. The franchisor has the legal right to withhold their approval if a franchisee brings forward a proposed buyer. Some do it to drive an exiting franchisee into a corner.
  3. The operator’s franchise agreement with the franchisor says: “If the franchisee breaches the agreement, in any way at all, (70 pages long, including operating manuals, debt payments, appendices, etc.) then that automatically means that the lease has been breached (cross-default: much easier, faster, cheaper to throw a franchisee onto the street than to sue them under the body of the agreement).
  4. It appears that there were some franchisee free riding but we’re only hearing Enzo’s side of the story. I don’ t think his life savings were on the line because of his “training and operational deficiencies”. Yeah right.
  5. On a breach with a “non-compliant” [shithead] franchisee, the franchisor and/or landlord can padlock the store but they can’t touch the equipment or supplies because it’s owned by the franchisee.
  6. The franchisee is therefore faced with: the right of ownership without any rights to the location to operate the business.

The next step is what happens 99% of the time:

  1. The franchisee acts like a sheep. He sells either to (1) the franchisor (who operates for a short or long time) or (2) to a new sucker (I mean, Canadian small business franchise investor). Seldom do they debrand and become independent.
  2. The franchisee sells because they think their business is worth, say, $400,000, and if they’re “a good little boy” the franchisor will let them keep 100% of the money.
  3. The franchisor (knowing that the business is a dog or wanting to crucify this franchisee as a lesson to the flock) lets them keep 20% instead of the normal 15% because they can control the sale 4 or 5 different ways

What I think happened THIS TIME:

The franchisee saw through the trap. He knew or suspected that they were going bankrupt no matter what they did and that the equipment was already “underwater” (ie. it was of zero value to them but tied to massive debt. The only value it held was, mostly, in-place to the franchisor).

  • The bank financed it for, say, $100,000 based on a bogus appraisal 12 months ago.
  • The bank’s own receiver would only realize 15% disposal.
  • The franchisor would re-buy the equipment (very specialized, an idiosyncratic sunk cost to be technical about it) on the day of auction and
  • then sell on to the next more compliant investor (Sucker2?).

Also he may have been wised to the fact that franchise bankers and franchisors have an “understanding”: long-term, very lucrative relationship spanning the whole franchise system over many years versus one lonely loser family.

ANALYSIS: Going bankrupt for either $300,000 or $250,000 or $450, 000 doesn’t matter very much, does it? The equipment may have actually been used when they opened up (when  they thought they’d be getting new.) The money that appears to be thrown away (on the street) was very minor when compared to the operating losses that have already take place.

The franchisee and his spouse as guarantors of the bank’s debt for the equipment (if they’re not already personally liable under the franchise agreement). btw: Incorporating a franchised business? Simply putting your lawyer’s kids through school.

And with the bank being able to have up to 90% of their loan paid for (if the equipment loan was cut from the Canada Small Business Financing program).

  • What do does the bank care if some street people in Montreal were carting away a small businessperson’s life saving?

Ah: The beauty of dealing with other people’s money.

  • the franchisor (franchisee’s life savings) and
  • the bank (the franchisee and spouse’s bankruptcy).

Of course, this is all entirely speculative.

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