IHOP 2012 Annual Report Download - page 39

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proceedings, a bankruptcy court may prevent the termination of the related franchise agreements and development agreements.
Any franchisee that is experiencing financial difficulties may also be unable to participate in implementing changes to our business
strategy. Any franchisee that owns and operates a significant number of Applebee's restaurants and fails to comply with its other
obligations under the franchise agreement, such as those relating to the quality and preparation of food and maintenance of
restaurants, could cause significant harm to the Applebee's brand and subject us to claims by consumers even if we are not legally
liable for the franchisee's actions or failure to act. Development rights for Applebee's restaurants are also concentrated among a
limited number of existing franchisees. If any of these existing franchisees experience financial difficulties, future development
of Applebee's restaurants may be materially adversely affected.
We are subject to credit risk from our IHOP franchisees operating under our Previous Business Model, and a default by
these franchisees may negatively affect our cash flows. Of the 1,404 IHOP restaurants subject to franchise agreements as of
December 31, 2012, over half operate under the Previous Business Model. The Company was involved in all aspects of the
development and financing of the IHOP restaurants established prior to 2003. Under the Previous Business Model, the Company
typically identified and leased or purchased the restaurant sites, built and equipped the restaurants and then franchised them to
franchisees. In addition, IHOP typically financed as much as 80% of the franchise fee for periods ranging from five to eight years
and leased the restaurant and equipment to the franchisee over a 25-year period. Therefore, in addition to franchise fees and
royalties, the revenues received from an IHOP franchisee operating under the Previous Business Model include, among other
things, lease or sublease rents for the restaurant property building, rent under an equipment lease and interest income from the
financing arrangements for the unpaid portion of the franchise fee under the franchise notes. If any of these IHOP franchisees
were to default on their payment obligations to us, we may be unable to collect the amounts owed under the building property
lease/sublease agreement and our notes and equipment contract receivables, as well as outstanding franchise royalties. The
additional amounts owed to us by each of these IHOP franchisees subject us to greater credit risk and defaults by IHOP franchisees
operating under our Previous Business Model may negatively affect our cash flows.
Termination or non-renewal of franchise agreements may disrupt restaurant performance. Each franchise agreement is
subject to termination by us in the event of default by the franchisee after applicable cure periods. Upon the expiration of the initial
term of a franchise agreement, the franchisee generally has an option to renew the franchise agreement for an additional term.
There is no assurance that franchisees will meet the criteria for renewal or will desire or be able to renew their franchise agreements.
If not renewed, a franchise agreement and the related payments will terminate. We may be unable to find a new franchisee to
replace such lost revenues. Furthermore, while we will be entitled to terminate franchise agreements following a default that is
not cured within the applicable grace period, if any, such termination may disrupt the performance of the restaurants affected.
Franchisees may breach the terms of their franchise agreements in a manner that adversely affects our
brands. Franchisees are required to conform to specified product quality standards and other requirements pursuant to their
franchise agreements in order to protect our brands and to optimize restaurant performance. However, franchisees may receive
through the supply chain or produce sub-standard food or beverage products, which may adversely impact the reputation of our
brands. Franchisees may also breach the standards set forth in their respective franchise agreements.
Franchisees are subject to potential losses that are not covered by insurance that may negatively impact their ability to
make payments to us and perform other obligations under franchise agreements. Franchisees may have insufficient insurance
coverage to cover all of the potential risks associated with the ownership and operation of their restaurants. A franchisee may have
insufficient funds to cover unanticipated increases in insurance premiums or losses that are not covered by insurance. Certain
extraordinary hazards may not be covered and insurance may not be available (or may be available only at prohibitively expensive
rates) with respect to many other risks. Moreover, there is no assurance that any loss incurred will not exceed the limits on the
policies obtained, or that payments on such policies will be received on a timely basis, or even if obtained on a timely basis, that
such payments will prevent losses to such franchisee or enable timely franchise payments. Accordingly, in cases in which a
franchisee experiences increased insurance premiums or must pay claims out-of-pocket, the franchisee may not have the funds
necessary to make franchise payments.
Franchisees generally are not "limited purpose entities," making them subject to business, credit, financial and other
risks. Franchisees may be natural persons or legal entities. Franchisees are often not "limited-purpose entities," making them
subject to business, credit, financial and other risks which may be unrelated to the operations of Applebee's or IHOP restaurants.
These unrelated risks could materially and adversely affect a franchisee and its ability to make its franchise payments in full or
on a timely basis. Any such decrease in franchise payments may have a material adverse effect on us. See the Risk Factor titled
"An insolvency or bankruptcy proceeding involving a franchisee could prevent the collection of payments or the exercise of rights
under the related franchise agreement," below.
An insolvency or bankruptcy proceeding involving a franchisee could prevent the collection of payments or the exercise
of rights under the related franchise agreement. An insolvency proceeding involving a franchisee could prevent us from
collecting payments or exercising any of our other rights under the related franchise agreement. In particular, the protection of the
statutory automatic stay that arises under Section 362 of the United States Bankruptcy Code upon the commencement of a