What is a director’s guarantee in a franchise agreement?

Director's guarantees have become commonplace in franchise agreements, but do you know what they involve? Legal experts explain

Some time ago, I received a message asking what the deal was with director’s guarantees and had there really been what was a perceived rise in their inclusion in franchise agreements. Where had they come from? And does anyone really sign one? The implications, after all, can be severe. In very layman terms, the director’s guarantee essentially makes you, the franchisee, personally liable for the financial failure of your business.

It means if all goes wrong, the franchisor can get money from you by taking your assets – including your house. It’s a sobering thought and a massive antidote to the success stories that are usually encountered when being onboarded into a franchise. However, it is an important reality check that while franchising is an opportune space to build something lucrative, it’s also a big personal investment that needs careful consideration and expert independent advice.

So, not being a legal expert myself, I spoke to Fiona Boswell, partner at Knights, Iain Bowler, partner at Freeths, Gurmeet Jakhu, franchising partner at Excello Law, and Emily Sadler, senior commercial solicitor at Harper James. These are professionals who have spent their careers aiding franchisees and franchisors in navigating the fine print of franchise agreements.

What is a director’s guarantee?

A director’s guarantee ultimately means you’ll pay from your own pocket should your business fail, which is why it can feel risky to franchisees. “For franchisees, a director’s guarantee introduces significant personal risk as the director becomes personally liable for all obligations under the franchise agreement, for the full extent of any losses suffered by the franchisor,” explains Emily.

In some instances, the director’s guarantee may also be used to claim damages, rather than pay off debt, according to Gurmeet. “A suitably worded personal guarantee may be relied upon by a franchisor to seek damages and compensation following a breach of contract (including but not limited to termination of the franchise agreement) from the director personally, rather than the franchisee company,” says Gurmeet.

Is the franchisee always the director?

In the majority of cases the franchisee will be the director signing the guarantee. “It would normally be the owner and controlling director of that limited company,” explains Fiona.

This could mean there’s more than one person signing the director’s guarantee. For example, four people who each own a 25% share of the company would likely have to sign the guarantee – making them all liable.

Why do franchisors include director’s guarantees?

From a franchisor’s perspective, franchising a business they’ve grown from the ground up can be risky because it brings more parties into the financial fold. The director’s guarantee protects them in case something goes wrong with a franchisee they’ve brought on board. “They’re looking for security,” confirms Fiona. “Ultimately they’re looking for a way in which to ensure that you’ll adhere to the franchise agreement.”

It’s also important to consider that while you, as the franchisee, are becoming part of the brand, your business is your own entity – like any other start up – which is why franchisors will treat it accordingly. “You’re setting up a new company that has no trading history,” says Fiona.

Have director’s guarantees just appeared?

Director guarantees in franchise agreements are considered commonplace in the legal arena – and have been considered so for some time. However, if you’ve franchised before but not encountered one, you’re not going crazy.

“There are some circumstances where directors’ guarantees are not included for emerging brands,” confirms Fiona. “Some brands don’t include it when starting out because they’re trying to attract franchisees to the brand and because it’s onerous.”

In these scenarios, brands will introduce the director’s guarantee once they’ve become more established. This can sometimes be a surprise to those initial franchisees when it comes to a renewal because it seems like a frightening addition – but is reassuringly normal.

In other cases, the director’s guarantee is there in the first place but has been overlooked or misunderstood, as some opt not to seek advice before signing.

“We’ve had a number of franchisees that have come to us that have signed agreements 10 years ago,” says Fiona. “They’re coming to us with a renewal and saying ‘this is really different’ and actually this was in the original, they just didn’t get any advice on the first one.”

Why can directors guarantees be added to a renewal?

It’s standard practice for iterations to make their way into franchise agreements when you renew. If you’re in the rare scenario where a director’s guarantee wasn’t there in the first place, it could be added within the renewal – regardless of your track record in proving your business’ financial health.

“Most franchisors will review their agreements from time to time. It’s our advice to do so,” says Fiona. “In the last five to 10 years, there’s been a lot of franchise case law that has changed things and that will need to be addressed in new agreements that are put in place.”

While there aren’t legal boundaries in how drastically a franchise agreement can be changed, there are ethical ones. “The current franchise agreement may differ from the original but ethically and in accordance with the BFA code of ethics which BFA members have to adhere to it shouldn’t be substantially different as to mean that you can’t operate the franchise profitability anymore,” says Fiona.

Given that the director’s guarantee has no impact on the profitability of your business, it wouldn’t be deemed inappropriate to add one to a renewal contract if it wasn’t there in the first place.

Does being a limited company help?

Some franchisees believe there are protections against the director’s guarantee, such as operating as a limited company, however that is simply not the case. “Effectively, the guarantee cuts away all of that protection that the limited company gives and makes you personally responsible for entering into the franchise agreement and gives the franchisor security to enforce against your personal assets,” says Fiona.

Can a cap be negotiated?

There aren’t many safeguards that can be put in place against a director’s guarantee, should your business fail. However, you may be able to negotiate a cap prior to signing your franchise agreement – although this is only agreed upon in a minority of cases. This could mean that you’ll only be liable up to a certain amount, such as nine months cover on the amount of anticipated monthly royalty.

How receptive a brand is to negotiation will be on a case-by-case basis. “It does depend on how established the brand is. If they’re a very established brand, it will pretty much be sign here, all franchisees will be expected to accept and give the guarantee, and there will be no room for negotiation,” says Fiona. “Where you have a more emerging concept or it’s a new brand to the UK, you may have more leverage in negotiating.”

On the flip side, you may also be able to negotiate your way out of a director’s guarantee if you’re a very established investor with a large portfolio of franchises because you have a track record. However, even in these situations negotiations can still be unsuccessful.

“Even the bigger, sophisticated multi unit, multi-brand franchisees get asked for personal guarantees by the franchisor and if you don’t provide the personal guarantee, you’re not going to get the franchise. It’s pretty much as simple as that,” says Iain, who works with numerous multi-unit investors and franchisors.

He’s encountered investors who will only sign a director’s guarantee with a cap – highlighting that if you take this approach, you need to be comfortable with walking away and honouring your ‘red line’.

However, he’s also witnessed successful negotiations. “There’s been multi-unit franchisees successfully negotiate new development and franchise agreements without a director’s guarantee at all,” he says. In other cases, franchisees have negotiated a reduction in liability as performance targets have been hit and revenue has accumulated. “By the time the director’s guarantee falls away that franchisor has had a three-year trading relationship with a significant franchisee organisation who’s proved themselves,” says Iain.

Ultimately, it could be quite difficult to negotiate your director’s guarantee, but it’s not impossible so may be worth discussing before you sign your franchise agreement.

Red flags

While director’s guarantees aren’t necessarily something to be alarmed by, some franchisor behaviour surrounding them could be cause for concern. In any scenario, it’s essential to seek independent legal advice to ensure your safety and understanding here. One particular red flag for franchisees can be if a franchisor asks for guarantees from you and everyone you’re connected with, despite them not being involved in the business. “If they are asking for guarantees for everybody in and around you, alarm bells should ring,” confirms Fiona. “You need to restrict that down to just the people involved in the franchise ideally.” If you’re unsure, raise your concerns with a lawyer.

Due diligence

While understanding the contents of the franchise agreement, such as a director’s guarantee, is one thing – it’s vital you double-check the basics. “Is it dated? Is it signed? Does it have any square brackets in it with information that was supposed to be there?” says Iain. If the franchise agreement and the director’s guarantee have not been properly executed they may not be valid. If it is valid, and you can’t cover the debt you’ll be made bankrupt. “If the value of your home isn’t sufficient to cover the liability, then you could be made bankrupt. And if you’re made bankrupt, you’ll not get credit in the future. You can’t act as a director. You might even struggle to get a job,” says Iain.

Seek legal advice

There are multiple cases where franchisees signed a director’s guarantee without really knowing what the implications were, or at least, couldn’t imagine they’d ever be in a situation where they’d ever come into play. The consequences of dealing with this can be devastating if you’re unprepared, which really highlights the importance of thinking about future you by seeking legal consultation on your franchise agreement. “Given the risks, franchisees should proceed with caution,” agrees Emily. “It’s crucial to thoroughly understand the implications of a director’s guarantee and seek professional advice to navigate these waters effectively.”

Why you need to resign from your director’s guarantee

If you leave the business, you need to leave your director’s guarantee by officially resigning through legal documentation. This is separate to your resignation from your job role at the company. If you don’t do this, you’ll still be liable despite no longer being involved in the company – an awful way that some people have been caught out.

“For you to no longer have any liability under the guarantee, you need to be released from it. It has to be discharged,” says Fiona. “You would need to approach the franchisor to have the guarantee expressly released and it needs to be done in a legal way by a deed of release. And if that doesn’t happen, you remain liable under the guarantee until it is discharged.”

Is there any benefit to the franchisee?

The director’s guarantee is really set up to protect the franchisor from financial loss. For the franchisee, the advantage is simply having access to the franchise brand they want to trade under. However, seeing as director’s guarantees are a fairly standard practice within franchise agreements, some reassurance can be taken that your chosen brand is operating above board.

“You’re not going to be joining a network of rogues that are just going to turn around and do what they want any time because everybody has this responsibility to adhere and be conducting the brand in a uniform way,” says Fiona. “That should give a franchisee some comfort that they’re not the only one in among this.”

How enforceable is a director’s guarantee?

If all goes pear-shaped with your business, a director’s guarantee is a relatively straight forward to process. “Most guarantees are unlimited, and the franchisor would generally not have to take steps to enforce any of its rights against the franchisee before pursuing the director,” explains Emily. “It means that the director’s personal assets (including their home) could be targeted if the franchisee fails to meet its commitments. In a worst-case scenario, it could mean bankruptcy for the director.”

Essentially, it’s fairly easy for the director’s guarantee to be acted upon, and it’s not a situation where you would have to wait for a court hearing to proceed.

Don’t get caught out by insurance

Many franchisees assume insurance can help out if they’re having trouble navigating or protecting themselves from the director’s guarantee. However, it’s important to read the fine print.

You could pay extra for insurance each month which may include legal cover, but does it cover legal disputes? If not, you’ll unlikely get any insurance help to deal with a disputed director’s guarantee. Some insurance companies may cover director’s guarantees, however it’s important you choose a reputable provider and choose wisely. They may be able to cover up to a percentage of the risk, but do ample research and expect fees.

Tell your partner

If your assets are jointly owned, it’s essential to inform your partner that you intend to sign a franchise agreement that includes a director’s guarantee. “A properly advised franchisor will insist that the director informs their partner, that they take independent legal advice and that the independent lawyer confirms to the franchisor that they have advised the partner,” says Iain. Your partner should understand the risk to your assets.

Words by: Molly Raycraft
Image credits: Shutterstock/hvostik/insta_photos/Ground Picture/fizkes/simona pilolla 2