Ask a franchise salesperson what happens if a unit stops working and you will hear about resale, about a negotiated handback, about closing the doors and settling up. What you will almost never hear is the federal process built precisely for a business that cannot pay what it owes, and the silence is not embarrassment. A franchise is one of the few small businesses where filing does not reliably buy the owner what filing is supposed to buy, and the mechanism that decides is a single subsection of the Bankruptcy Code.
The contract has to be kept or given up
A franchise agreement in an operating unit is what the Code calls an executory contract: both sides still owe each other performance. The basic rule is short. Subject to the court's approval, the trustee may assume or reject any executory contract or unexpired lease (11 U.S.C. § 365). In a reorganization where the owner stays in control of the business, the owner makes that call with the powers of a trustee.
Assumption is not free, and this is where owners are most often surprised. To assume, the debtor has to cure the defaults or give adequate assurance of promptly curing them, compensate the other party for actual pecuniary loss from those defaults, and provide adequate assurance of future performance. Translated into a franchise: back royalties, unpaid advertising-fund contributions, and arrears on any franchisor note come due as a condition of keeping the brand, generally at the front of the case rather than spread across a plan. An owner who filed because the arrears had become unpayable finds that the same arrears are the price of continuing.
Rejection is the other door. It is a breach rather than an erasure, leaving the franchisor a damages claim riding with the other unsecured creditors, and the owner with no license, no marks, and whatever post-termination obligations the agreement makes survive.
The trademark question that splits the courts
The complication peculiar to franchising sits in the next subsection. Assumption is barred where applicable law excuses a party other than the debtor from accepting performance from, or rendering performance to, an entity other than the debtor, and that party does not consent. Trademark licensing is ordinarily treated as exactly that kind of personal arrangement, which is why franchisors invoke the provision.
Courts read the subsection two incompatible ways, and the divide is real rather than academic. The hypothetical test asks whether the contract could be assigned to a third party in the abstract, and bars assumption if the answer is no, regardless of whether the owner has any intention of assigning anything. The actual test asks whether the franchisor is genuinely being asked to accept performance from someone else, and permits assumption where the same owner simply keeps running the same unit. A November 2025 survey in the American Bar Association's Business Law Today places the Third, Fourth, Ninth, and Eleventh Circuits on the hypothetical side and the First and Fifth on the actual side, and catalogues recent decisions still adding to the split.
The import for a buyer is blunt. In some parts of the country a franchisee who files cannot keep the franchise over the franchisor's objection even while paying everything current, so the reorganization tool other small businesses rely on may not be available on the terms you assumed. Where the unit sits is part of what decides that.
The lease runs on a clock of its own
A unit with a storefront carries a second contract, and the Code treats it less patiently. An unexpired lease of nonresidential real property must be assumed within 120 days of the order for relief, or by the date a plan is confirmed if that comes first, with the court able to grant a single 90-day extension if it is asked before the first period runs out. Beyond that, further extensions require the landlord's consent.
Seven months sounds generous until you notice what has to happen inside it. The lease decision cannot be made sensibly until the franchise decision is, because a location without a brand is worth something entirely different, and the franchise decision may be waiting on a contested motion. Owners who file late, with weeks of cash rather than months, run out of runway before either question is answered.
Which chapter, and what the small-business track changes
The chapter matters as much as the timing. A liquidation puts a trustee in charge, and the franchise ends unless someone buys it with the franchisor's blessing. A reorganization leaves the owner running the business, but the ordinary version is expensive enough that it rarely fits a one-unit or two-unit operation.
The narrower track built for exactly that problem is subchapter V, created by the Small Business Reorganization Act of 2019. It appoints a trustee alongside the owner, and reserves the right to file a plan to the debtor. Eligibility is a debt ceiling: combined debts of $3,424,000 or less, a figure that rose from $3,024,725 with the inflation adjustment effective April 1, 2025 and is next due for adjustment in 2028 (Chapter 11 — Bankruptcy Basics, Administrative Office of the U.S. Courts). Franchise debt adds up faster than owners expect once the note, the equipment financing, the lease obligation, and trade payables are counted together, so eligibility is worth calculating.
Three things a filing will not undo
Most of the disappointment in this area comes from expecting the process to reach further than it does.
- An agreement already terminated. There is nothing to assume once the franchise relationship has ended, so a franchisor that completed a termination before the petition has generally taken the asset off the table. Timing is the whole ballgame, and it runs against an owner who waits.
- A personal guarantee. The protection of a case filed by a business entity runs to that entity. A guarantee is the instrument designed to reach past it, which is why the guarantee and the entity are two separate questions requiring two separate conversations.
- The obligations drafted to survive. Post-term non-competes, confidentiality covenants, de-identification duties, and indemnities are written to outlive the agreement, and a rejection is a breach of the contract rather than a release from what the contract says continues.
There is one protection that does arrive immediately and is worth understanding accurately. Filing stops collection activity, judgments, foreclosures, and repossessions while the case proceeds. That pause is real, and it is also just a pause: it creates the time in which the assume-or-reject decision gets made, and nothing more.
What to do with this before you ever need it
Treat the whole subject as diligence rather than contingency planning, because the useful work all happens before signing. Read the default and termination provisions with one question in mind: how fast can this franchisor complete a termination, and would a struggling owner realistically still hold a live contract at the point of filing? Count the notice days and the cure days, and check the state addenda at the back of the disclosure document, since several states extend both.
Ask your attorney which test the circuit covering your location applies, and write the answer down next to your financing plan. Add up what a total debt load would look like at full build-out, and compare it against the subchapter V ceiling. If you are financing through the brand, note that the same franchisor is then both your licensor and a creditor, and that the arrears which must be cured to keep the license are partly owed to the party deciding whether to object.
None of this is a reading to attempt alone, and none of it predicts anything about a particular deal. It is a question about the shape of the downside, and it belongs in the same conversation as the personal guarantee and the lease, with a franchise attorney and a bankruptcy attorney who practice where the unit will operate. Owners who learn the material afterward tend to say the same thing: they found out how narrow the options were once they had run out of the cash required to use any of them.