What a wreck: Attempted rejection of implied franchise leads to dismissal of bankruptcy cases

Blog Post

This spring, the United States Bankruptcy Court for the District of Delaware found that the bankruptcy case of Rent-a-Wreck, the car rental business, could be dismissed for bad faith because of its long and ongoing dispute with one of its franchisees. (See In re Rent-A-Wreck of America, Inc., 2018 BL 48230 (Bankr. D. Del. 17-11492)) The case serves as a cautionary tale for franchisors that are in some type of financial distress due to particularly contentious disputes with their franchisees; bankruptcy cannot be used as a tool to simply discard a particularly problematic franchisee. 

All of Rent-a-Wreck's problems leading to the bankruptcy spawned from its disputes with its original owner, David Schwartz. 

Schwartz founded Rent-a-Wreck in the 1970s and although the company was eventually sold, Schwartz maintained his original franchise location in Los Angeles. However, Schwartz’s location was never a traditional franchise – no franchise agreement ever existed and Schwartz failed to pay any royalties to Rent-A-Wreck, despite his ongoing use of the Rent-a-Wreck trademarks and systems. Schwartz protected his alleged "franchise rights" by filing multiple lawsuits and appeals over the course of a decade, which Rent-a-Wreck vigorously defended. In turn, Rent-a-Wreck filed numerous claims against Schwartz. 

Eventually, a court found that Schwartz had an implied in fact, royalty-free Rent-a-Wreck franchise – but even this decision did not solve the acrimonious relationship between the parties. Rent-a-Wreck continued to divert customers from Schwartz's franchise location and eventually Rent-a-Wreck was found in contempt. Allegedly, this finding of contempt, along with Rent-a-Wreck's ongoing “financial distress,” drove Rent-a-Wreck into bankruptcy in July 2017. Soon after the bankruptcy filing, Rent-a-Wreck filed a motion to reject Schwartz's franchise, but Schwartz objected to the motion to reject. Schwartz also filed a motion to dismiss the bankruptcy cases for bad faith, alleging that Rent-a-Wreck was simply abusing the bankruptcy system to thwart him and get rid of his franchise – not because of Rent-a-Wreck’s alleged “financial distress.” If Rent-a-Wreck was ever in any financial distress, Schwartz alleged, it was self-inflicted through its years of vigorously contesting Schwartz’s efforts to protect his original franchise location. 

The bankruptcy court considered the motion to reject and the motion to dismiss the bankruptcy together during a multiple-day evidentiary hearing, and the court eventually found that it was clear that Rent-a-Wreck filed bankruptcy in bad faith in an attempt to discard Mr. Schwartz’s franchise. A court considering a motion to dismiss a bankruptcy may consider the totality of the circumstances, to “see where a petition falls along the spectrum ranging from the clearly acceptable to the patently abusive.” (See In re Integrated Telecom Express, Inc., 385 F.3d 108, 118 (3d Cir. 2004)) Here, the court found that Rent-a-Wreck was not in the type of financial distress that is typical of debtors under the Bankruptcy Code – in fact, an officer of Rent-a-Wreck testified that Rent-a-Wreck did not claim to be insolvent, and there were no threats from unsecured creditors threatening to drive them into bankruptcy. Most of Rent-a-Wreck’s financial issues simply stemmed from its years of disputes with Schwartz regarding the validity of his franchise. Further, the non-financial evidence that Rent-a-Wreck presented did not support a finding of good faith. While Rent-a-Wreck asserted that its “valid reorganizational purpose” was to maximize its trademarks and eliminate the risk of further litigation, the court simply found that “the primary purpose of the bankruptcy filing is to reject Schwartz’s franchise agreement so that Debtors can open the Los Angeles territory to multiple royalty-paying franchisees.” Noting that Rent-a-Wreck’s bankruptcy petition “falls on the dark side of the spectrum” of what may be classified as good faith in bankruptcy cases, the court approved the dismissal of the bankruptcy case. 

A cautionary tale for franchisors

In the future, franchisors who may be tempted to file bankruptcy to gain a tactical advantage over a franchisee should be advised to consult the Rent-a-Wreck opinion; it offers a clear warning to franchisors who might otherwise use the bankruptcy system to attempt to discard a troublesome franchisee.

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