America's franchise businesses and hospitality sectors are on the front line of the economic damage and havoc caused by the coronavirus pandemic. The unique nature of these businesses will require quick, creative, and customized action by the franchise community and bold government support if they are going to survive and continue as critical engines of the American economy.
The Franchise Community Is an Ecosystem of Small and Large Businesses That Depend on One Another
As noted by the International Franchise Association, there are more than 700,000 franchise businesses in the United States that employ over 7 million people and contribute nearly $675 billion in output to the U.S. economy. This franchise community is an ecosystem of interconnected business relationships that depends on the cooperation and financial health of all the component parties, including large, mid-sized, and small franchisees, franchisors, management companies, suppliers, and other third-party vendors. The business interests of these various parties are connected by many factors, including the brand standards central to the franchise relationship, the franchise and license agreements that govern the relationship, and the supply chains and information flow critical to the operation of a franchised business. Accordingly, the franchise community's response to the COVID-19 pandemic will require frequent and frank communication, as well as creative actions customized to the particular circumstances of various franchise relationships.
The Franchise Community Must Take Immediate and Coordinated Action
The pandemic already is inflicting tremendous financial damage on the franchise and hospitality sectors, and this damage will expand exponentially in the coming months. Hotel occupancy levels have dropped below 25%, and the American Hotel & Lodging Association recently released data estimating that the pandemic may result in the loss of nearly 3.4 million hotel and hotel-supported jobs. The National Restaurant Association anticipates restaurant sales will decline by $225 billion over the next 90 days, which could result in the loss of 5 to 7 million jobs, and the International Franchise Association has noted that 20,000 to 30,000 franchise businesses could lose liquidity in the next 45 days without immediate relief.
In light of these dire circumstances, the following are major issues franchisors and franchisees will need to address in responding to this crisis.
Health and Safety. The paramount concern for all businesses in this crisis must be the health and safety of customers and employees. Because of the interconnected nature of the franchise relationship, franchisees and franchisors must communicate openly and ensure they are on the same page in deciding whether to keep franchised units open and in implementing cleaning and physical distancing procedures.
Unit Closures. Franchisors and franchisees must coordinate on decisions and procedures for closing franchise units, whether such closures are mandatory based on shelter-in-place or similar orders by state and local governments or voluntary business determinations. These decisions and policies will need to be customized to account for a variety of different factors, including the type of business, and the unique public health circumstances, economic conditions, and legal requirements of the location of the business.
Brand Standards. Franchisees are adjusting and will continue to adjust their daily operations in response to the pandemic: for example, restaurants that have switched focus to take-out and delivery operations in lieu of dine-in service. Franchisors will need to grant franchisees flexibility to adjust their operations to the daily realities of the pandemic while protecting the value of the brand and maintaining consistency in system standards to the extent possible. This may entail temporary waivers of operational requirements that are monitored on a regular basis as circumstances change or the extension of due dates for upgrading equipment or renovating facilities.
Fee Relief. Franchisors and franchisees already are beginning to negotiate fee relief measures as economic activity comes to a standstill and revenues plummet. These measures are likely to include the deferral of franchise fee payments and marketing contributions initially, with the potential for full or partial waivers of such fees and contributions depending on the duration of the economic contraction.
Contractual Interpretation and Modification. The franchise or license agreement governs substantially all the obligations and responsibilities of the franchise relationship, and most of the issues franchisors and franchisees will need to work out in responding to the pandemic, including unit closures, waivers of brand standards, fee relief, and claims on business interruption insurance proceeds, will require analysis and interpretation of contractual provisions and the negotiation of amendments, waivers, and/or forbearance agreements.
Venable's Hospitality team is available to assist clients in preparing and implementing contingency plans and actions to address the issues described above and other issues relating to the COVID-19 pandemic.
Government Action Required to Support the Entire Franchise Community
The federal government and the states have taken numerous actions to help individual Americans and businesses deal with the pandemic, including the expansion of paid sick leave and additional funding and support for small business emergency loans, and Congress is on the verge of enacting additional legislation that would provide an unprecedented stimulus to boost the American economy. These stimulus measures include the following proposals:
- Direct cash payments of $1,200 to many Americans, expanding unemployment insurance;
- $350 billion in federally backed small business loans to help small businesses meet payroll costs; and
- $500 billion in funding for corporate loans and loan guarantees administered by the Treasury Department.
The stimulus measures directed at individual Americans and small businesses have drawn bipartisan support and will provide needed relief to small and mid-sized franchise businesses and their employees. There was significant disagreement among Republicans and Democrats regarding the measures that would benefit larger companies, principally over concerns about transparency, accountability, and the appearance of bailing out large corporations, but it appears negotiators have resolved most of these issues. It is critical to the franchise community that the stimulus measures include liquidity and capital support that large franchisors and franchisees can access; otherwise, the measures that should support small franchise businesses will not realize their intended effect and billions of taxpayer dollars being deployed to help stem the economic damage could end up being wasted. Because of the interconnected nature of a franchise system, the financial health and viability of smaller franchisees often is closely tied to that of the franchisor and other large system franchisees. The hospitality industry illustrates this dynamic: while small businesses own thousands of franchised hotels across the country, the top five hotel franchisors collectively represent more than 80% of the total franchised branded rooms in the United States, according to STR and JLL Research. Ensuring that small business owners of franchised hotels have access to loans and other resources to keep employees on the payroll and maintain relationships with suppliers will not have the intended effect if the large hotel franchisors that franchisees rely upon to manage and maintain strong franchised brands do not have the necessary liquidity to weather the impact of the economic crisis. Similarly, hotel franchise systems consist of a variety of franchisee owners, ranging from individual owners of one or two hotels to publicly traded REITs that own multiple hotels, and the health of a franchised system's brand depends on the continued health and viability of substantially all franchisee owners, small and large.
We will continue to monitor legislative developments regarding the COVID-19 crisis and update clients on the final legislative package as well as additional government action that may be necessary to support the franchise community and hospitality industry.
Venable's Hospitality team draws upon more than 50 years of dedicated industry experience to provide counsel to many of the world's largest hotel brands and management companies, as well as hospitality investors and REITs. If you have any questions regarding this article or if you would like assistance with your organization's response to the COVID-19 crisis, please contact a member of Venable's Hospitality team.