The Franchise Memorandum

In In re A&F Enterprises, Inc. v. IHOP Franchising LLC, 2014 U.S. App. LEXIS 2408 (7th Cir. Feb. 7, 2014), the Seventh Circuit reversed the district court and the bankruptcy court and stayed the enforcement of the bankruptcy court orders that were on appeal. The dispute in the bankruptcy case involved when a debtor-franchisee must assume or reject a real property lease for a leased franchise location. Under bankruptcy law, a debtor must assume or reject a commercial real property lease within 120 days after the bankruptcy case is filed or the lease is deemed rejected. In contrast, a debtor may assume or reject an executory contract such as a franchise agreement at any time prior to, or by means of, the confirmation of a chapter 11 plan. In this case, the leases and the franchise agreements for the franchisee’s restaurants were cross-defaulted. When the franchisee did not assume the real property leases within the 120-day time period, IHOP took the position that the real property leases could not be assumed because they were deemed rejected and, as a result, the franchisee also lost the opportunity to assume the franchise agreements. The bankruptcy court agreed with IHOP’s position and the franchisee appealed to the district court. The franchisee also sought a stay pending appeal from first the bankruptcy court and then the district court. Both of those courts denied the stay request.

The Seventh Circuit reversed, applying a standard similar to that used for granting a preliminary injunction. Noting that the franchisee might permanently lose its franchises absent a stay, the court determined that the potential harms weighed in favor of the stay. The potential harm to the franchisee, according to the court, outweighed any damage to IHOP’s good will and trademark resulting from the franchisee’s continued operation, because the franchisee’s use of the trademark would be improper due only to bankruptcy time limits and not as a result of breaches of the franchise agreement. The court also found that the franchisee’s claim had substantial merit.

The underlying bankruptcy court decision regarding the assumption period applicable to the franchise agreements and related leases remains on appeal to the district court. We will provide an update when the court issues a final decision on that issue.