Bank Approval for Franchise Sale / Purchase

Buying and selling a franchise is rarely, if ever, a simply task - as there are all too often a multitude of complexities, hurdles and pressures bearing down upon the parties involved.

Contact Neufeld Legal PC for franchising legal matters at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

The sale of a franchise that has an existing bank loan or other financing arrangement cannot be undertaken without conforming to the requirements imposed by the bank (financing company) and set out in the loan agreement (financing agreement), which tends to not only require the prior approval of the bank (financing company), but may also have other contractual requirements set out in the written agreement.

Although the specific requirements for attaining the bank's approval to undertake the sale of one's franchise are set out in the loan agreement (financing agreement), there are common requirements and conditions that banks and financing companies typically impose to protect their financial interests in the money they have lent:

A. Loan Repayment or Assumption

The primary concern for the bank is how the existing loan will be handled. The loan agreement will contain a "due on sale" clause, which typically means the loan must be repaid upon the sale of the business. You will likely have two main options:

• Pay off the Loan (Most Common): The sale proceeds are used to fully pay off the outstanding balance of the existing loan, along with any accrued interest or prepayment penalties, at closing.

  • Bank Requirement: The bank will require a "payoff statement" showing the exact amount needed to clear the debt on the closing date. They will often want the proceeds wired directly to them.

• Buyer Assumes the Loan (Less Common): The buyer takes over the legal responsibility for the existing loan. This is only possible if the loan agreement allows for assignment/assumption, and the bank must formally approve the new borrower.

  • Bank Requirement: The bank will treat the buyer's application for assumption as a new loan application. The buyer must meet the bank's current lending standards, and provide a comprehensive set of financial documents, personal and business tax returns, and a solid business plan for the continued operation of the franchise.

B. Collateral Release

• If the existing loan is secured by the assets of the franchise (equipment, inventory, accounts receivable, etc.), the bank holds a security interest (a lien or charge) on those assets.

  • Bank Requirement: The bank will require the security interest to be discharged or released upon full repayment of the loan, to ensure the buyer receives the assets free and clear of the prior debt. If the buyer is assuming the loan, the bank will transfer the security interest to the buyer as the new borrower.

C. Consent and Documentation

• The bank may need to review documentation related to the sale to ensure their interests are protected.

  • Purchase and Sale Agreement: The bank may want to see the Purchase and Sale Agreement, especially the section detailing how the loan will be settled.

  • Franchisor Approval: Since the business is a franchise, the bank may require proof that the franchisor has approved the buyer and consented to the transfer of the franchise agreement (a requirement of most franchise agreements).

Attempting to sell one's franchise without first obtaining the bank's approval carries significant dangers, primarily because it violates critical legal clauses in most loan agreements (and financing agreements). Among the major risks and consequences of attempting to sell a franchise without the bank's prior approval:

• Immediate Loan Default and Acceleration:

  • Breach of Contract: The loan agreement almost certainly contains a clause that makes transferring ownership (a "change of control") or assigning the loan's obligations without the lender's prior written consent an event of default.

  • Loan Acceleration: By triggering a default, the bank has the right to accelerate the entire loan, demanding the full remaining balance be paid immediately.

  • Forced Liquidation or Foreclosure: If you can't pay the accelerated balance, the bank can move to seize the assets that were pledged as collateral for the loan. This may include the franchise's equipment, inventory, and even the business property, effectively dismantling the sale and the business itself.

• Loss of Personal Guarantee:

  • Personal Liability: Most small business and franchise loans require the owner to sign a personal guarantee. If the bank accelerates the loan and the business assets aren't enough to cover the debt, the bank will then pursue your personal assets (like your house, savings, or investments) to recover the remaining balance.

  • No Release from Debt: You won't be released from the original loan obligation simply because you sold the business. The bank approved the loan based on your financial strength and the business's assets. Without their approval to transfer the debt to the new buyer, you remain legally and personally responsible.

• Breach of Franchise Agreement:

  • Franchisor Approval: Separately from the lender, virtually all franchise agreements require the franchisor's approval for any transfer or sale of the franchise business.

  • Termination: Selling the business without the franchisor's consent is a material breach of the franchise agreement and gives the franchisor grounds to terminate the franchise. This could instantly devalue the business for the buyer and trigger further legal action from both the franchisor and the buyer.

• Complications for the Buyer and Lawsuits:

  • Clouded Title: The sale is fundamentally flawed because the assets remain subject to the bank's security interest and the seller's debt. The buyer may have difficulty obtaining their own financing or clear title to the business assets.

  • Buyer Lawsuit: The buyer, upon discovering the unauthorized sale and the resulting bank default, would have a strong basis to sue you for rescission of the sale, fraud, and damages, leading to expensive and protracted litigation.

The approval of the bank / financing company is but one of the parties from whom permission is typically required when selling a franchise, with the seller also needing to engage with the franchisor, the landlord, equipment lessors, suppliers, and regulators.

Christopher Neufeld is a business lawyer knowledgeable in the rigors and challenges of the franchise business, together with the legal constructs that are critical to their effective operation. For experienced legal representation in starting, acquiring / selling, operating and managing a franchise, contact franchisee lawyer Christopher Neufeld at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or Chris@NeufeldLegal.com.