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How effective are Personal Guarantees in Franchise Agreements?

How effective are Personal Guarantees in Franchise Agreements?

What is a personal guarantee?

A guarantee is a contractual promise to pay the liabilities of another.

When a franchise agreement is entered into between a franchisor and a corporate franchisee, such as a limited company, it is usual for the franchisor to require at least one individual, such as a company director or key shareholder, to provide a personal guarantee that they will satisfy the obligations and liabilities of the franchisee, in the event that the franchisee fails to meet those obligations and liabilities under the franchise agreement. This is particularly important in relation to fees due under the franchise agreement. Franchisors want business owners to have ‘skin in the game’ to promote adherence to the franchise agreement.

In the franchise agreement, the person giving the guarantee is often referred to as the “Individual” or the “Principal”.

Most personal guarantees are unlimited, unless expressly limited or capped by a limitation of liability clause or an exclusion clause. Guarantees can also cover payment of damages for future loss arising from an early termination.

What are the requirements of a personal guarantee?

A personal guarantee under a franchise agreement must be in writing and witnessed by an independent person. When executing a franchise agreement whereby an individual is signing on behalf of the franchisee company and an individual is providing a personal guarantee to the franchisor, then there should be separate execution clauses for both.

In circumstances where there is more than one individual involved in running the franchise business, a franchisor can require two or more individuals to each give personal guarantees under the franchise agreement. For example, where there are two business partners. In these instances, both individuals are liable on what is known as a ‘joint and several’ basis to the franchisor. This means that a franchisor can pursue either, both individuals jointly or, pursue one of the individuals personally for the full amount of the loss.

Guarantees are subject to general contract law principles and this includes an intention by the parties to create legal relations. This was considered by the Court of Appeal in our case of Dream Doors Ltd v Martin Lodge [2012] EWCA Civ 1556.

In this case, the franchisor Dream Doors had entered into a written franchise agreement with a franchisee, Lodgeford Homes Ltd. Mr Lodge was a director and shareholder in  Lodgeford Homes Ltd and Mr Lodge had signed the franchise agreement on behalf of Lodgeford Homes Ltd writing the words  “as a principal” above his signature. The parties fell into in dispute. The franchise was terminated.

Dream Doors issued an injunction against Lodgeford Homes Ltd and Mr Lodge to enforce the post termination restrictions as they were competing. The Court in the first instance decided that Mr Lodge was acting as an agent of Lodgeford Homes Ltd and therefore was not personally bound by the terms of the franchise agreement.

However, the Court of Appeal overturned the first judge’s decision as the Court had failed to consider relevant pieces of evidence relating to the negotiation and entry into the franchise agreement which indicated that the parties intended that Mr Lodge was to also be bound by the terms of the agreement. This included that the franchise agreement was intended to replace an existing agreement under which Mr Lodge had acted as a guarantor, and named principal.

Can a personal guarantee be avoided?

As stated above personal guarantees are subject to general contract law provisions therefore for such to bind there must be consideration, such as payment for the subject matter of the contract. If there is no consideration, i.e. the person giving the guarantee receives nothing in exchange from the franchisor, then the guarantee will be unenforceable, unless executed as a deed.

It can be advisable for franchisors to draft their franchise agreements with the personal guarantee as a separate schedule to ensure that the personal guarantee is executed purely as a deed.

A guarantee may be set aside if was procured by undue influence.

Franchisors should be prepared to demonstrate that they have taken reasonable steps to ensure an independent decision is made when seeking personal guarantees from individuals who will not be involved in the running of the business (Barclays Bank Plc. v O’Brien). Therefore, franchisors should check that individuals take independent legal advice so that they are fully aware of the obligations and risks attached to the obligations in the franchise agreement and guarantee they are signing.

In the case of Beardsley Theobalds Retirement Benefit Scheme Trustees v Yardley, a company employee had signed a lease as a personal guarantor of his employer’s obligations under a lease after being told that his signature was required simply as a witness on a legal document. The Court found that the employee could rely on the defence of undue influence and therefore the  guarantee was unenforceable.

A guarantee can also be avoided if it can be shown that the guarantor was misrepresented to prior to signing.

In the case of Ali and Others v Abbeyfield VE Ltd [2018], joint venture partners commenced proceedings against the Defendant for misrepresentation. The joint venture partners were required to sign (alongside the joint venture agreement), a personal guarantee which covered the overdraft provided by the Defendant to the joint venture partner plus the Defendant’s loan to the joint venture partner.  In this case, some of the Joint Venture partners were required to sign and return personal guarantees to the Defendant within 2 days of receipt.

The Court found that the joint venture partners had been induced to enter into the joint venture agreements as a result of misrepresentations on the part of the Defendant. This meant that the personal guarantees provided by the joint venture partners were voided.

Personal Guarantees can have significant impact on individuals. If a franchisee is in significant breach of a franchise agreement and the individual has provided an effective personal guarantee, it will allow a franchisor to take enforcement steps against the individual personally. This may include drastic steps such as taking a charge against any property owned by the individual or a charge over other assets they may own.

Advice to Franchisors and Franchisees regarding Personal Guarantees

Franchisors should carry out due diligence prior to entering into a new franchise agreement to ensure that any individual giving a personal guarantee is financially viable, that the individual is not a former bankrupt, not based abroad, and has the financial means to meet payment demands under the personal guarantee should the franchisor need to pursue them in the future.

It is also advisable for franchisors to have all owners of the franchisee company sign a personal guarantee so that they can pursue either all owners or individual owners and recommend that they take their own independent legal advice.

Franchisors must also make sure that when the franchise agreement is being signed, that there is proper consideration and that it been validly executed (in the presence of a witness who attests the signature of the guarantor) before being filed safely.

Further, the owners of franchised companies may also consider negotiating with their franchisor to set a cap or limit on the amount the franchisor can pursue them personally under the personal guarantee they are giving under the franchise agreement.