Tricky business: Non-monetary defaults in franchise agreements and the potential impact on assumption or rejection of franchise agreements in bankruptcy

A recent opinion out of the United States Bankruptcy Court for the Northern District of Illinois evaluates interesting facts and circumstances surrounding non-monetary defaults and their impact on the potential assumption or rejection of franchise agreements in a bankruptcy case.  In re IYS Ventures, LLC, No. 23 B 6782, 2024 WL 1464455, at *11 (Bankr. N.D. Ill. Apr. 4, 2024). The debtor, IYS Ventures, LLC (the “Debtor”) was an operator of 49 gas stations across the United States. Forty of the stations were leased from Cross America Partners, LP (“CAP”), an entity that supplied fuel to all of the stations, and the Debtor owned nine of the stations that were operating.

A number of agreements governed the relationship between CAP and the Debtor, including a Franchise / Fuel Supply Agreement, Leases, and certain agreements related to intellectual property. CAP filed a motion in the Debtor’s bankruptcy case to compel the Debtor to reject the majority of the Franchise / Fuel Supply Agreements, or in the alternative, grant CAP relief from the automatic stay.  The Debtor also filed a motion to approve assumption of the Agreements. 

The Franchise / Fuel Supply Agreements included a number of important provisions, including:

• A right of first refusal
• A requirement that the Debtor purchase fuel exclusively from an affiliate of CAP in specified volumes
• A specification that neither party had a fiduciary relationship with the other
• A specification that neither party is an agent of the other, and that the Debtor was an independent contractor of CAP

The Debtor entered into a number of management company agreements with certain management companies, and a dispute developed between CAP and the Debtor as to certain of the management company relationships; CAP alleged that the Debtor had breached the franchise agreements because of certain issues with the management company set up and day-to-day management. CAP also alleged that the Debtor breached the right of first refusal and the anti-assignment provisions in the agreements when the Debtor allegedly assigned the agreements to its management company. Notably, the parties did not dispute that there was any monetary default under the agreements. 

Once the Debtor filed the bankruptcy, however, the Debtor and CAP filed dueling assumption / rejection motions concerning the assumption or rejection of the agreements and the parties’ ongoing relationships. The court took extensive testimony on the Debtor’s relationship with the management company and whether the Debtor had outsourced its managerial responsibility under the franchise agreements to the management company. The Debtor’s executives testified that the management company was “not in control of everything,” “they still work for me”, and “I’m literally overseeing them.”  The court also noted that the franchise agreements provide that the Debtor is an independent contractor “with the ability to manage its locations however it deems appropriate.” The Court found that the management company agreements were not an impermissible assignment of the franchise agreements, and the Debtor did not default under the agreements with CAP through any violation of the anti-assignment / right of first refusal provision.

The court also considered a number of non-monetary additional alleged defaults CAP raised; CAP’s position was that these non-monetary defaults prevented the agreements from being assumed and assigned and could not be cured. In addition, the court evaluated whether these defaults were material or caused “substantial economic detriment” to CAP; the defaults were not material, they did not prohibit potential assumption and assignment. Ultimately, the court found that the additional alleged non-monetary defaults were not material, and this would not prevent assumption and assignment.

CAP also requested that the court compel the Debtor’s rejection of the franchise agreements because of the alleged defaults. The Court found that it did not have the authority to compel rejection, but could only limit the time period in which a debtor in bankruptcy may do so. Ultimately, the court approved assumption and assignment of the franchise agreements because it “would be beneficial to debtor’s estate and would serve to advance the reorganization of the Debtor.”

Overall, this case illustrates the importance of considering the impact of any potential defaults, whether non-monetary or otherwise, before any franchisee bankruptcy. It also highlights the power that a debtor in bankruptcy may have to exercise some element of control on the potential assumption or assignment of franchise agreements through the bankruptcy process.