Can a creditor/lender secure loans to a franchisee, and a licensee with royalty payments from the franchise and license agreements or with an equity interest in the debtor LLC?
As explained below, the royalty payments cannot serve as security for a loan to the Debtor LLCs because these payments are being made by the Debtor LLCs to the franchisor and the licensor. Only property/ revenue belonging to the Debtor (e.g., accounts receivables, not accounts payable) can serve as collateral/security. As for the equity interest in the Debtor LLCs, this may be possible, but would be subject to possible restriction in the Debtor LLCs’ operating agreements and is subject to restrictions
in the franchise and license agreements.
A. Law Governing Agreements
Florida has adopted Revised Article 9 of the Uniform Commercial Code regulating secured transactions.
The adoption of this body of law ensures that regardless of any term within a franchise or license agree- ment, or any other such general intangible, they can serve as collateral/security for a loan. The actual benefit of having such collateral/security, however, is subject to any lawful restrictions contained in the franchise and license agreements.
B. Inquiries Regarding Particular Sources Of Collateral
Royalty payments are the primary form of collateral securing loans to franchisors. Under the instant scenario, however, the franchisee is seeking financing. Consequently, the royalty payments cannot
serve as collateral under either Agreement because the payments only flow from the franchisee to the franchisor (i.e., franchisee’s accounts payable). Further, although Florida allows the franchise agreement to serve as collateral for a loan to a franchisee, the benefits of such collateral are very limited in nature, as the Secured Party is not entitled to enforce its security interest in the franchise agreement. See Fla. Stat. § 679.4081(4)(f); ALM GL ch. 106, § 9-407(d)(6) (same). Nevertheless, the Secured Party may be able to secure the Debtor’s accounts receivables (e.g., daily receipts from patrons—less royalty payments).
Often, agreements would prohibit the parties to the contract to transfer their rights in the franchise/license without the franchisor/licensor’s consent—thus preventing a majority ownership interest without consent. See Windy City Grill, Article16.2 (“the franchisee and the principal will not have the rights to effectuate any transfer without the prior written consent of the Franchisor”);
On the face of these anti-assignment clauses, they would also appear to prohibit use of the franchise
or license as security for financing. Florida recognize, however, that such clauses cannot prevent the perfection of a security interest in the franchise/license and cannot constitute cause for the franchisor or licensor to claiming a breach of contract. See Fla. Stat. § 679.4081(1); ALM GL ch. 106, § 9-407(a); see also id. cmt. 5 (confirming purpose of statute to make such provisions ineffective to prevent the creation of a—limited—security interest).
Florida also provide, however, that the security interest is not enforceable against the franchisor, nor
is the franchisor even required to recognize the secured party or its security interest. Further, the ability to use the franchise agreement as security does not otherwise override the Agreements restriction on assignments of the franchise agreement; thus, in this case, the Secured Party would not be entitled to assign the Debtor LLCs’ interests to itself or a third party unless the franchisor or licensee consent to the transfer of the Debtor LLC’s interests in the franchise or license.