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Franchise Agreement Not Properly Terminated Pre-Bankruptcy

Bankruptcy, Restructuring & Creditor's Rights Alert Lauren Beslow

A recent ruling in the bankruptcy case of RMH Franchise Holdings, Inc. (RMH), the second largest franchisee of Applebee’s restaurants with over 160 franchises, highlights the importance of using clear and unequivocal language and action to effectively terminate an agreement before the filing of a bankruptcy. Dine Brands Global Inc. et al. v. RMH Franchise Holdings Inc., et al. (In re RMH Franchise Holdings, Inc., et al.). RMH stopped making royalty and marketing payments to Applebee’s in June 2017, and by the time RMH filed for bankruptcy in May, 2018, it owed over $12 million to Applebee’s. Under the Bankruptcy Code, a debtor has the option, subject to certain conditions including cure of monetary defaults, of assuming executory contracts (i.e. contracts where there are remaining obligations due from both parties) and assigning those contracts to third parties. The automatic stay that takes effect upon the filing of a bankruptcy case precludes non-debtor contract counterparties from taking action to terminate those contracts, and protects the debtor’s right to make its determination as to assumption and/or assignment. If the Applebee’s contracts were deemed to not be part of RMH’s estate due to Applebee’s pre-petition termination of those agreements, then RMH would lose its right to cure and then retain or assign those contracts to a third party.

The franchise agreements (each restaurant was governed by a separate agreement) granted Applebee’s the right to terminate immediately upon a breach resulting from the failure to pay royalties and/or advertising fees, by providing written notice to the franchisee. Applebee’s sent a letter to RMH in September, 2017, giving notice that the franchise agreements would automatically terminate on the 91st day if the default remained uncured. Through a series of letters, Applebee’s extended the cure deadline several times without re-asserting its termination rights. Ultimately the cure period was extended until April 27, 2018; Applebee’s then sent a letter whereby it agreed to forbear enforcement of its rights until May 8, 2018. On the day the forbearance was set to expire, RMH filed for bankruptcy protection.

Applebee’s filed a lawsuit within the bankruptcy case asking the Court to declare that the franchise agreements had been terminated before the bankruptcy was filed. If so, the franchise agreements were not property of the debtor’s estate and Applebee’s would be entitled to immediately exercise its remedies, including the right to take over the restaurants. If not, the automatic stay would prohibit Applebee’s from exercising its remedies and RMH might be able to retain its rights under the agreements and continue to operate thereunder in a reorganization, and/or pursue a sale.

The state law governing the franchise agreements provided that termination of a contract must be clear and unambiguous and convey an unmistakable purpose to terminate. Applebee’s claimed that the automatic termination provision in the September, 2017, letter carried over through each subsequent letter and effected a termination at the end of the last cure period on April 27, 2018--two weeks before the bankruptcy was filed. It also argued that the subsequent forbearance letter did not modify the prior termination, but simply delayed the exercise of its post-termination rights. RMH, on the other hand, argued that Applebee’s did not provide adequate notice of intent to terminate because the letters did not make it clear that the franchise agreements would terminate or had terminated, and, instead, conveyed Applebee’s willingness to delay exercise of its termination rights until the May 8 petition date.

The Court agreed with RMH that the cure extension letters did not provide “clear and unambiguous” notice of intent to terminate and that the franchise agreements were property of RMH’s bankruptcy estate. The Court noted that Applebee’s did not provide for a definite termination date, nor did it make it clear that it had intended to terminate the franchise agreements on April 27, 2018. It further held that because the forbearance letter stated that Applebee’s would delay enforcing its rights and remedies, without mentioning that it was only referring to post-termination rights, the “only reasonable interpretation” was that Applebee’s “committed to delay enforcing all of its rights, not simply its post-termination rights.”

This case is a reminder to all contract parties that in order to effectively terminate an executory contract so as to preclude that contract from becoming property of a debtor’s bankruptcy estate, and preclude the debtor from assuming and/or assigning such contract, termination must be clear and unambiguous from the documents and the parties’ actions.