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Unbridled Capital

Season 2 Episode 9: Restaurants and Bankruptcy



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While bankruptcy isn't something that any of us love talking about, for those in the restaurant industry, it's important to have some understanding in your back pocket. Tom Ice and Andrew Stosberg from Middleton Reutlinger Law joins Rick as he discusses the following topics and more:

1. What happens when distress hits
2. Chapters 7 and 11 bankruptcy
3. Potential franchisor issues


Welcome to the Restaurant Boiler Room, season two, episode nine. I'm your host, Rick Ormsby, managing director at Unbridled Capital. Today in the boiler room we infuse a recent webinar talking with Middleton Reutlinger attorney specializing in bankruptcy, Andrew Stosberg, and he's going to talk with us about how bankruptcy and distress will affect the franchise industry. The Restaurant Boiler Room is a one stop shop for multimillion dollar merger and acquisition activity and financial complexities affecting the franchise restaurant industry. We talk money, deals, valuations, and risk delivered to the front door of franchisees, private equity firms, family offices, large investors, and franchisors on a monthly basis. Feel free to find our content at Unbridled Capital website at Now, let's enter the boiler room.

Welcome everybody to the Unbridled Capital website... or pardon me, webinar... with Middleton Reutlinger attorneys. We're going to be talking a bit about restaurants and bankruptcy. Now, this is an area I've played in quite a bit from a standpoint of being brought in to sell companies, but I'm not the expert here. These two gentlemen are. You know me. There's not much more to say about me. But I just invite Tom and Andrew to introduce themselves a bit. Before I do so, I'll just let you know that we have a very familiar relationship with them. They're in Louisville, Kentucky, and they've probably been on, would you say guys, a dozen or more of our unique transactions on either the sell side or buy side.

Somewhere in that vicinity, sure.

Yeah, over the last couple years. A lot of times we're on the same side of the fence working on behalf of our clients. Hi guys.

Hi. I'm Tom Ice. I've been a lawyer now for almost 25 years. I started out as in house counsel with Steak 'n Shake and moved back to Louisville, as Rick indicated, back in '99 and I've been with Middleton since then. I'm chair of our business group. Most of my adult life has been spent working with restaurants, particularly in the QSR industry: Pizza Hut, all the Yums, Papa John's, McDonald's, Wendy's. Pretty much you name it, I've touched upon it. It's a new environment we're living in now, and Andrew and I will talk about that. But I invite Andrew to introduce himself now as well.

Hi. I'm Andrew Stosberg. I've been practicing for about 20 years and my background is corporate financial distress issues with a concentration on business bankruptcy and business insolvency issues. Obviously, in this environment things have become challenging with all constituencies. Business owners, landlords, franchisors, lenders, etc. There are a lot of moving parts on the chess board and the time for practicing and understanding of savvy... I'd call it... negotiating issues, identifying them, is what I enjoy. That's my background. There's a lot happening in the area of financial distress and Tom and I look forward to getting into that this afternoon, particularly with a focus on the restaurant industry.

Thanks for that introduction, guys. For everyone watching and listening, there's a summary of what we're going to talk about. We'll go through just a bit of an introduction to bankruptcy and what's going on in the restaurant industry from these gentlemens' perspectives. We're going to talk about what happens when distress hits. We'll go through Chapter 7, Chapter 11, sub, Chapter 5 of the bankruptcy codes for your guys' familiarization. Through this, I hope we're going to be able to lay out some specific examples. What I've learned from talking to these gentlemen is that it's difficult to make an example that fits every type of distress situation because they're all completely different from one another. Nonetheless, maybe we can develop some themes and think about a couple of examples that might be helpful to you. We'll talk about how the franchisor plays in this process and then maybe conclude with a summary of what to do if you are in trouble.

Again, I would just say before we get started... and then I'll turn it over to these gentlemen... I don't get a lot of joy out of talking about people's distress and problems. But the bankruptcy process, or the threat of bankruptcy process, can be a useful tool to right size and make a business more healthy when difficult times arise. With that, I'll turn it over to Tom and Andrew.

Thank you. First, while this is a distressing topic for a lot of people, a lot of positives can come out of both analyzing this as a potential option, as bankruptcy as a potential option, and just examining your company. We hope to turn this into a positive discussion on ways that we can all come out of this ahead. I'm just going to touch on the marketplace briefly. We all know if we're struggling or we're not. QSRs seem to be outperforming, and surprisingly so, in a number of industries while others are struggling. With that being the case, thought, bankruptcy filings are up, not surprising at all, over year to year. Leading the way are restaurant bankruptcy. But there is some light at the end of tunnel. As Rick alluded to and we talked about before this started, we have seen an uptick in our M&A deals, and Rick has as well. When I read all the analysts, there is a substantial bet that the food service and restaurant industries are going to come back pretty strong.

To that end, Congress is right now looking at the Restaurants Act. It's been proposed. It has bipartisan support. We expect it to be passed, but until it passes who knows. But we're looking at 120 billion dollars being put into the restaurant industry, primarily to assist with independent non-publicly traded restaurants and franchisees with 20 units or less. These are grants. It's not a loan. It's a PPP. The first round of funding would be provided to those that have a million five in sales or less in 2019 on a per unit basis. What you would get is the difference between your 2019 sales and what your projected 2020 sales are. If you have a million foreign sales in 2019 and you're projected to do a million in 2020, you get a 400,000 dollar grant from the federal government to assist with maintenance, utilities, payroll. It's a whole laundry list of things but it's a wonderfully positive thing and really being pushed by the supply chain.

If those things don't work and somebody's forced to look at bankruptcy there's something to consider in this first. Andrew and I refer to this as the path of last resort. First, most of the franchisees are going to have personal guarantees of some sort, whether they're with their lenders, landlords, suppliers, or the like. When you put your company into bankruptcy, that doesn't do anything to alleviate the issues associated with a personal guarantee normally. There are some instances where it could but more often than not the personal guarantees will remain in play and are subject to enforcement. Those business owners are then forced to decide whether they're going to put themselves into bankruptcy as well, even if they can. If not, then the filing of the business bankruptcy could have a negative effect on them personally.

Second... and I'm sure that most people on this call have been dealing with some sort of forbearance and abatement agreement. They somewhat speak for themselves, although you can get creative. What I wanted to touch on here is we are first and foremost in a relationship business, whether it's with our lender, our landlord, our supplier. It's important throughout your relationships to try to keep these on as positive a basis as possible, being as proactive as possible, so you can work out the deals in a more amicable fashion as they come due. It's easier to work with somebody you trust and you're friendly with than somebody that you're not. I'm right now dealing with a situation with a landlord and a tenant that they hate one another primarily because they've never listened to one another and maybe they're not trusting folks to begin with. But it's causing the deal that should be worked out to simply not be able to be worked out. What we're looking to do when forging these relationships is remain open, remain in contact, so that when bad things happen you're not dealing with a distrusting environment. We can go to the next-

[crosstalk 00:08:01] forbearance agreement, Tom? What would be an example?

What we've got is... What happened more often than not when COVID hit was the PPP money came out, restaurants were forced to be shut, so we contact the landlord and the landlord said, "I'll work with you but we need to get something in return. We'll give you a forbearance in rent for April, May, and June but we want six months added to the back of the lease or we'll increase rent in 2021 to make up the difference." The heartening thing as a lawyer is we spend so much time fighting with people or negotiating with people. Almost universally, people worked with us. I represent landlords and tenants. A few cases aside like the one I just alluded to, more often than not we've been working together.

As we have further shutdowns, if they do come, I don't know if that market will continue because landlords have bills just like anybody else. I remain hopeful, but everybody's got to work together for that type of system to work.

The other thing that our franchise clients are going to know if they're borrowing money, which most of them are, is these forbearance agreements are important when it comes to the [inaudible 00:09:07] money as well, just like landlords. Okay, next slide.

Next one is mediation. Courts are largely closed or limited or not going to hear you. In some cases, there are ordinances or statutes preventing lenders or landlords from foreclosing anyway in this environment. The economy's still got to move. In the case I alluded to before... the landlord and tenant hate one another... that attorney and I, the attorney for the landlord and I, discussed having a mediation. That seems likely. I got a talk with another one of my partners and they are going to mediation to try to keep the ball rolling because even if we're fighting and payments can't be made we still need one another and services have to be provided. We need to keep the ball rolling. Mediation outside of a court setting has become more and more popular, especially because access to courts is just simply not going to be there.

As an easy example, solely due to COVID, one of my friends had a trial scheduled for the first week of August in 2020. That trial has now been bumped to the first week of August in 2021. You're not going to get a ready solution to problems when you need to resolve them. You need to work together. Mediators, especially when there's an emotion in the room, can help get that done.

Asset surrender. It's not a common occurrence. It normally takes place with one or two unit operators where they can't make it work. The lender's pounding at their door and they just essentially hand over the keys and transfer the assets. It doesn't happen on large scales often. Lenders don't want it to happen because restaurants have much more value as going concerns so they will do whatever they can to prop the business up for sale. This notion of asset surrender can oftentimes morph into something called an Article 9 sale where you essentially give over the assets to the secured lender for the purpose of sale. You keep it going and then you sell it.

The final thing associated with this is threat of bankruptcy and this can happen with lenders, suppliers, landlords, or the like. You get a default letter. An easy example: you're late on a payment. You have 10 days to make that payment. You call the lender and say, "I can't make the payment. I'm sorry. Can we work something out?" Going back above to the forbearance agreement. And the lender says no. You say, "I'm left with no other option but then to file for bankruptcy." The lender says, "Wait, let's talk about that before you file." Because of the stuff that Mr. Stosberg's going to talk about, they'll oftentimes... and it's not universal. Sometimes lenders or landlords or suppliers want you to go into bankruptcy because the system is lost and kind of needs that guidance. But there are times... and we as lawyers use it... where you call that but you got to be willing to put it into bankruptcy. But if you are, then I say, "Look, you've left us with no choice. We're preparing, but if there's a deal that can be made we need to make it now," because we can't let that default period run because they can then enforce their rights under their agreement. You have to file before that default period runs. [inaudible 00:12:09] tool to get it done.

But if we can't get it done, that's where we have to call Andrew. We can go to the next slide and Andrew can...

Just one quick point here, Tom. I guess you touched on it. You don't want to have an empty threat. If you're going to threaten bankruptcy I think... and we'll talk about this towards the end of this webinar... you need to have a plan. You don't want to be willy-nilly about this. You want to get in front of it. You want to be proactive. You want to identify which of your creditors are not getting paid and what the likelihood that they're going to try to force legal action against you, and then you need to talk with your advisors to understand because bankruptcy is not a favorable outcome for the person filing bankruptcy for many reasons. I know that's true. With that being said, let's come on in to Andrew. The white knuckle guy, Andrew.

Thanks Rick, thanks Tom. I want to just piggyback on that theme of the threat of bankruptcy. I hope everyone here today can leave understanding... The whole purpose of running through some of these bankruptcy concepts I'm about to get into is any negotiation is all about leverage. The concept of bankruptcy is a significant tool in your toolbox to help with a negotiation, whether it's with a secured lender, whether it's with your franchisor, whether it's with your landlord, or whether it's with a key vendor. If you're in a rough spot with any of those constituencies, having a conversation where you can play out the chess game and say, "If you keep pushing on me I'm going to have to hit the bankruptcy button, and here's what happens in bankruptcy..." And as we get into some of these slides, more often than not in bankruptcy these constituencies that you're negotiating with, they're going to lose control and their options are going to become limited to the point where the lender, the landlord, the adverse party maybe will likely reconsider their initial position and back off some of the aggression. Then you ultimately get a deal done without having to go through the exercise of a bankruptcy and you get a favorable resolution that allows your business to recover and resume the path toward thriving where you want it to be.

Against that theme, there are two general types of bankruptcy and I'm going to briefly touch upon the more vanilla of the two, which is Chapter 7. A Chapter 7 bankruptcy is a liquidation bankruptcy. I would say it happens but it's rare, particularly for restaurant operators, to put their business through a Chapter 7. Why is that? Well, if you're putting your business in a Chapter 7, the owner or operator loses control of it and instead a trustee comes in and takes control of the business. When I say the business, the trustee is really taking control of the assets and very rarely will even operate the business. Usually the business will close. The trustee focuses on identifying assets, securing those assets, and then coming up with a plan to quickly liquidate those assets commonly through an auction, sometimes through a private sale as well. Once all of those liquidation activities are completed then the trustee will distribute the liquidation proceeds to the business's creditors. Again, it's very rarely that the equity or the ownership will get money distributed to them in a Chapter 7 situation. That only happens when the assets are worth so much and all the other creditors are paid a full 100 cents on the dollar.

Again, I don't want to spend too much more time other than to mention Chapter 7 as an opportunity for a business to have an orderly systematic liquidation of its assets, but it's not especially common for a restaurant to go through that process. They...

Restaurants are cash flow businesses. If you try to liquidate a restaurant's assets, you're going to get a couple of tortilla shells and some used equipment. [inaudible 00:16:20]. But they're cash flow machines, man. It's not like you're building cars and you have a big warehouse of parts that are worth 20 million dollars.

That's right. So we'll go to the next slide and this is where we'll spend the bulk of our time: Chapter 11 bankruptcies, which is the pathway for a reorganization for a business to partake in, is the first note in the case when you file a Chapter 11. It's somewhat of a [downsider 00:16:50]. It's a very transparent process. When you file you put in a public record a number of very detailed statements and schedules. You'll list all of your creditors and debts. You'll list past payments that were made during the 90 day period. Even in some cases you go back as far as a year. If you make payments to affiliates or other insiders of the business, those are all disclosed in the public filing. You'll identify all of your contracts, including leases, and then you'll sit down and you'll meet with a watchdog called the United States trustee who will review all of those filings. It's almost like an IRS audit in a sense.

There's a lot of transparency involved with a Chapter 11 filing, which of course means you want to be prepared on the front end if possible as opposed to doing a last minute rush job, which can be accomplished but it makes the process more stressful. Another downside with Chapter 11s is they can expensive and time consuming, and that's time consuming both from the attorney's side and the owner/operator's side. Again, filling out all those papers I just alluded to is a hyper detail process. You want to have someone who's a very good right hand man or woman who's great with the books and has a good grasp of what the balance sheet is, assets and liabilities, etc.

That touches upon the next point, which is there is a fatigue process to Chapter 11. Because of all the time crunch everything is ultimately, or can be, an emergency and there's a lot of work to do on the front end. In addition, the judges are typically very business sophisticated. They commonly have a business background of their own. A lot of them will be corporate litigation or corporate attorneys. Several bankruptcy judges have MBA backgrounds and they take great interest and usually have a pretty natural instinctive understanding of a lot of the business issues that bring the companies into Chapter 11.

Finally, you hear this term reorganization. More often than not a, quote, reorganization in Chapter 11 ends up as a very measured and structured sale. Sometimes that's the goal. Day one of the bankruptcy filing, the debtors and maybe their lender in collaboration and the prospective buyer know going in, "We're going to do this sale," but for a variety of strategic reasons it makes sense to accomplish the sale in a bankruptcy as opposed to doing it outside of a bankruptcy. The, quote, reorganization oftentimes can be a sale. Sometimes it's a planned sale that I just alluded to. Other times if the bankruptcy stretches out for many months and the key creditors and/or the judge get, we'll call it, fatigue, then there'll be a push and the debtors will ultimately be... for practical or legal reasons... forced to do some kind of a sale. It can be an auction or it can be a private sale where we bring in... the debtor can hire an unbridle to help broker that deal, solicit prospects, and get a deal done.

I'll touch on a key point for buyers of units in bankruptcy. Love Chapter 11 bankruptcy sales, which are commonly referred to as 363 sales. 363 is a reference to a commonly cited provision in the bankruptcy code. That provision in the code allows the assets to be sold free and clear of all leans, claims, and liabilities subject to the right motions getting filed in the court. The moral of the story is the purchaser gets clean title to assets when they make that purchase and any trade and any liabilities get left behind in the bankruptcy. The purchaser gets good, clean title and doesn't have to worry about any vestige liabilities. That's a big plus about accomplishing the sale inside a bankruptcy.

I guess that I'll just add in here kind of a layman's comment, but the first point here is that there are reasonable prospects of the continuation of the business. If you're a franchisee on this call and you're in trouble of some kind and you're contemplating next steps, maybe you have these forbearance agreements in place and you don't think there's a reasonable way you can pay your landlords back. Or maybe you're so far behind on your franchise or royalty and advertising payments. Or maybe your lender... you're in a forbearance agreement with your lender and you don't think you're going to be able to perform. Or maybe it's a combination of these things in the end with your supplier. I just would say that most of the restaurant businesses and the franchisees and friends that I have has a business that has a reasonable outcome to it, whether it is relieving debt or renegotiating leases or closing stores that have become unprofitable in a portfolio that... maybe a 50 unit portfolio that has 10 stores that have become unprofitable that are dragging the organization down because sales have dropped or the brand hasn't performed well.

I guess that's just a key point in here. Any comments on that, guys?

Especially as it relates to... and we'll get into it when we talk about commercial leases, but it can be a way to get rid of locations that just aren't... that are dragging the entire system down. It doesn't come without its pitfalls, and we're seeing bankruptcies right now that have been filed for that express purpose in the restaurant world because they've got areas where they simply cannot operate, whether you're in a theme park or you're associated with some other entertainment venue that just... Your other stores are operating but these five or 10, as you alluded to, are dragging the whole system down. You may need to go into bankruptcy in order to get rid of them if you can't otherwise work out a deal.

Yeah. Or maybe you operate in multiple markets like a lot of these large franchisee who have multiple brands. Maybe you have hundreds of restaurants and several of the markets you're in are high minimum wage markets who languish in sales and people don't like to eat fast food there any more and it's dragging your whole business down and you're cross-[collateralizing 00:23:22] all of your loans. There's all kinds of examples. Sorry to interrupt you there as you were talking.

So I touched upon the sales aspect, but then we'll get to the other aspect which is a true reorganization. You're the owner/operator. You want your business to emerge from bankruptcy successfully after you address some key problems that are clamping down your business and keeping it from succeeding. The way you do that in Chapter 11 is ultimately through the preparation and filing of a plan of reorganization, which has to be approved and confirmed by the court. There are generally two ways that that plan gets confirmed. One is you have the key constituencies or, quote, classes of creditors and parties and interests vote in favor of the plan. That happens in some cases and there's usually front end work that happens before the bankruptcy filing. You give the key players a heads up: "I'm filing for bankruptcy and here's why and here's what I believe can be accomplished. Will you generally support this subject to seeing everything be filed in the bankruptcy." Most of the key players say yes and then the filing occurs and the Chapter 11 process moves along relatively quickly with a limited amount of contested matters and adversarial skirmishes.

The other way, which is more common, is you have groups or classes of creditors that are against the plan. Typically the common mode of theirs is the obvious. The group... let's say it's a group of unsecured creditors... that they may just get paid a few cents on the dollar on their total claims. Another example might be a landlord or a couple of landlords are going to have their leases rejected and the amount... and I'll talk about a rejection of the lease, but their lease will effectively go away and the landlord will get little by way of any sort of breach, damages, or termination damages as a result. So there are opposing classes oftentimes in a Chapter 11.

However, the plan can be, quote, crammed down. That's point number two, where if you have one class of creditors, a majority of whom in number vote in favor of the plan... and that majority also has to be two thirds in total dollar amount of the class. So there's two metrics you look at: the majority number and the two thirds supermajority of the dollar amount of the class claim. If you get a group of creditors to vote in favor of the plan then the other groups of creditors that are against the plan, their objections are overridden and the plan is, quote, crammed down on those dissenting creditors. A key part of cram down... and this is going to be important when we start talking about the sub Chapter 5 that was recently passed that's especially designed for small businesses. A key point of cram down is when creditors are not being paid in full. The ownership can't survive. The current equity cannot survive and maintain the ownership unless they put, quote, new value into the bankruptcy plan, which typically is they write a significant check to help fund the plan. In other words, the owners go in out of pocket a significant amount of money to maintain his or her ownership in the bankrupt companies because of the cram down situation.

That's not always feasible, and certainly not appealing, to an owner who maybe already has his or her own financial distress issues because of the personal guarantee obligations or they've put a lot of their savings into trying to save the business on the front end. Cram down is challenging sometimes on the ownership.

[inaudible 00:27:22] Andrew. Just out of percentages of the deals you've done, how many of these Chapter 11s go by consent versus cram down? 50/50? That's quite a tough question.

It is. I would say certainly more often than not it's going to be cram down. It would be less, maybe 75-25, in favor of cram down. Maybe 33-66. Something like that. But what's nice about bankruptcy is deals are always cut at the 11th hour. In fact, the judges will often facilitate those negotiations before a big hearing starts up or even in the middle of a big hearing. The judge will often pause and give a little editorial and suggest "This is a really difficult issue we're litigating. I think it would behoove all the parties to take a 30 minute recess. Go out in the hall and talk about it before we go down with continuing litigation. If we do go down with continuing litigation, I can tell you that the court is going to make a very absolutely draconian ruling one way or the other. There will be no middle ground. The parties need to know that they're in an all or nothing game of chicken. You all should think about that for 30 minutes and talk about it." A lot of times these fights that are seemingly heading toward a nasty cram down fight, suddenly the parties emerge at the 11th hour with a consent deal.

Makes sense. All right, next one. Key bankruptcy terms and concepts.

I want to remind everybody... and we'll come back to that cram down area and what an owner has to do typically in traditional Chapter 11s and how, in the new piece of legislation, there's a great exception for business owners that we're going to talk about when we get into these concepts and then the new legislation.

So some concepts. One of the benefits of a bankruptcy is that the second you file your case all efforts to collect debts, to really antagonize a debtor in any way, are automatically stayed by operation of law. If there is a foreclosure proceeding that has been initiated by the landlord, that is stopped in its tracks the second the bankruptcy is filed. Or if your secured lender is getting ready to swipe your bank account, if you bank with your secured lender, or foreclose, the ability for the lender to do that is stayed. Also, the stay can affect the other party to a key contract, whether it's a landlord or a vendor. They cannot enforce default remedies due to the automatic stay. That's a huge benefit of a bankruptcy filing.

The debtor in possession. That is a legal term of art that's important because when you're the business owner of a company you have to operate the business in a manner that is beneficial to all of your creditors while you're in bankruptcy. The ability to make more gray area self-serving pro-owner decisions is much more limited. You have more of a fiduciary duty as a debtor in possession to operate the business in a manner in bankruptcy that's going to help the creditors. If owners don't behave that way they run the risk of having an outside party ask the court to appoint a trustee to kick out the owner for debtor in possession obligation. That's a limitation that exists in bankruptcy that's important.

I imagine as one of the franchisee's best tools to get the best outcome in Chapter 11, is the fact that while they're in the Chapter 11 if they're the debtor in possession they're the ones that are operating the business and presuming they operate the business well that's one of the key pieces [inaudible 00:31:11] collecting as much money and getting the best outcome as possible, I would think. Unless you run into a franchisee that's just an awful operator, in which case you want to jettison them from the whole picture I would think.

That's right. And as you touched upon, Rick, it is a high standard gross mismanagement when the operator loses their debtor in possession status and the trustee kicks them... gross mismanagement broad. Very high degrees of bad conduct.

DIP financing and cash collateral. A lot of restaurant owners, they may have leans on their assets including, for example, accounts receivable. Those accounts receivable can constitute and become cash collateral. Any form of cash collateral cannot be used during a bankruptcy unless you get court approval for doing so. Typically to get that court approval you have to provide assurance to the lender that their position won't deteriorate during the bankruptcy. If you can provide them replacement leans or some form of monthly payment... Again, the goal is status quo. If a restaurant operator is using cash collateral, the collateral base should not deteriorate as a result of the debtor's actions and usage of the cash collateral. The other thing, financing, is the debtor needs to borrow money while in bankruptcy. They have to seek advance written approval from the bankruptcy court through the filing of a motion. Again, taking on extra debt can't be to the detriment of other secured creditors. There's a process where the other secured creditors get an opportunity to look at the loan package, examine the financing that's proposed. Again, the standard is the existing secured creditors' position shouldn't deteriorate as a result of an action such as borrowing money. If you're borrowing money it's to maintain the value of the going concerns.

Just maybe something you would see in a COVID-19 situation, right? Let's say you have a lender that is owed 20 million dollars. At the current moment the business is in Chapter 11. Your cash flow from operations is negative even before paying rent because of the situation we find ourselves in. So the lender is looking and saying, "I'm going to have to loan the franchisee three or four million dollars to keep the operation afloat in order that I can recover a majority or a portion of my 20 million dollars that he already owed."

Oftentimes they're going to provide that money to, as Andrew indicated... A lot of times in Chapter 11 the companies end up being sold. The DIP lender will provide that money, and it's usually the secured lender in the first place, in order to keep the going concern, to keep the value, elevated so somebody like you can assist in the sale of the company.

Right. And a common tool used to address these issues we're all raising is there is... a detailed budget is employed so all the parties looking in on the case have a roadmap. They can see where the money is going, for what purpose it serves. And it's very common that budget is submitted. Usually whatever's submitted is not what is ultimately approved. There's usually some give and take and debtors typically file something that outside parties will say some of the line items are inflated or have some fluff and let's shrink them or just eliminate them altogether. A budget is a very key tool and component for helping with these DIP financing and and cash collateral issues.

363 asset sales. I touched upon that earlier. Again, Chapter 11 is a wonderful venue for conducting sales of distressed asset. As I alluded, it may be by private or public bid. Typically, the debtors will hire outside professionals whether they're brokers, investment bankers, is needed to help with these asset sales and to help get them completed. Again, the sale process is extremely transparent. In the case of an auction, there are usually bidding procedures that are approved and filed with the court. Then the auction occurs consistent with the bidding procedures that have been presented and approved.

In the case of a private sale, the standard that the sale has to be typically the fairest and best offer. Oftentimes that's the highest bid. But then you get into quagmires where, for example, you may have one buyer that wants to buy 10 units for X amount and then you have another buyer that wants to buy five of the 10 units but the purchase price for the five of 10 units is maybe 80% of the first buyer who wants to buy all 10 units. How do you compare which of those two offers is highest and best? That's an example of a challenging situation that will ultimately be addressed and decided by the bankruptcy judge. There's a quick evidentiary hearing and usually a lot of a times it's funny how many last minute ups in the purchase price happens between those two competing parties. But private sales happen all the time in Chapter 11 and Chapter 11 is a great venue for the purchasers because, again, at the end of the day they're going to get assets free and clear once the bankruptcy sale process is completed.

We're going to be rolling through the rest of this. We've got about 10 minutes to get through five more slides, so hammer out your key thoughts there.

The exclusivity period means that once a debtor files, the debtor and only the debtor has the ability to file a plan. A competing creditor can't jump in and hijack the case from day one. You get at least 120 days, oftentimes longer.

Commercial leases. Again, when you deal with a contract in bankruptcy, including a commercial lease, you have the ability to either keep that lease or, quote, assume it. Or you can kill off and get rid of that lease, which is called, quote, rejecting the lease. The goal with your good leases is you want to find a way to keep or assume them but you have a time limitation period to do that. It's initially 120 days on a commercial real estate lease. You can get that extended one time for 90 days by the court. After that you need the landlord's written consent. The moral of that story is you want to constantly be proactive with the landlords of your good units you want to save. You're definitely on the clock for 120 to 210 days to get that done.

One misconception on the leases that oftentimes when people come to us: the court's not going to intervene to amend your lease. If you're going to assume your lease, you're assuming the lease as written. If you want to amend the lease you need to go to that landlord and strike a deal with that landlord. There is no court intervention there. The court's not there to help you in that regard.

That's a great key point.

Let me ask a couple of questions here. Couple of questions coming in. Hit them real quickly. What about an Article 9? That was a question.

Article 9, that goes back earlier in the slide. An asset surrender. Usually they're part and parcel where your secured lender, if they're going to foreclose on the assets or if the assets are surrendered to the secured lender, they have to do a commercially reasonable sale. They have to give notice to the debtor about that along to any other existing secured creditors that may have an interest in the assets. It's a very form regimented, check the box type of process that the secured creditor has to follow.

And it's not done as frequently as I think they believed it was going to be done when they passed revised Article 9, because it has to be done strictly in accordance with the statute. If you fail in one area then the sale itself can be in jeopardy. It's that strict compliance that freaks people out so they seek alternative ways to get it sold, although I've done Article 9 sales, so they're doable, but they're not as popular as I think the people who drafted the statute believed they were going to be.

Getting in one more question real quickly. If a company is in Chapter 11 can the company still complete transfers of existing franchisee units? Would the transfer be subject to an approval by the trustee? Can they offer new franchise agreements?

That sounds like multiple questions but the short answer is... I'll give the best lawyer answer... maybe, but those things can be accomplished in the bankruptcy court. They would need to be disclosed and approved by a motion that would be evaluated by the court and parties and interests in the case would have an opportunity to object if they feel like it was not appropriate.

My guess is the question is, "No, you can if you're in bankruptcy. Just sell some of your units on the side." I think that's the nature of the first question. It would be subject, right, to the entire process.

Any sale of property that is outside the ordinary course requires court approval. Sales of assets that are ordinary... Of course, if you're a restaurant selling your food you don't need to run to the court every time you want to sell a value meal.

Here's a question. What about personal guarantee? In reality, is my personal home in danger? In your career, have you seen bankers go all the way to personal guarantee to recover every little bit? This is probably going to be a central question of people [crosstalk 00:41:00].

I think that's a fact specific and fact driven argument. Yes. The answer is absolutely seen the 10 million dollar check be written on a personal guarantee. Oftentimes they're fought in some capacity for some reason. Some underlying fact, some intervening fact, will get in the way. Sometimes it's a relationship that the banks are looking to preserve long term, so they'll strike a deal for less because oftentimes these guarantees say you're guaranteeing the entirety of the debt. Let's say there's 10 million dollars owed. The company may have six or seven million dollars in assets. The guarantee will let that bank go after the 10 million dollars immediately without going after the assets of the company. But sometimes the bank will look at that and say, "We're not looking to ruin somebody. We're going to take whatever now. We're going to preserve a right and we're going to foreclose on those other assets, get the value of those, and then seek the difference in the guarantee." But it's a wide spectrum and one that some banks are known and notorious for being really difficult. Others are not.

But it goes back to something I said before. You're less likely to have a draconian action taken against you if you have a good working relationship with your bank and you stay on top and you're not viewed as being somebody who's fraudulent or lying. So maintaining these... Don't stick your head in the sand. When you know you're going to default call your banker and tell them "I'm going to have a problem here. I want to sit down and talk with you. I want to work out a deal." Maybe that keeps you out of bankruptcy, maybe it doesn't, but trying to keep the exposure on the personal guarantee as limited as possible is the primary goal here I think for most of the people on this call.

I've seen this many times happen. Since there's very few assets in a restaurant beyond the cash that it generates, if you do have a significant personal guarantee that's at risk and you're considering a bankruptcy just remember that you do have some chips at the table. You operate the business and if you don't operate the business well the business... I'll tell you. I can tell you this: the business immediately drops in value. Then in the sale, the creditors immediately get less value for their business. You do have some negotiating tools if you're a good operator and you're in a bad situation. That's all I'll say.

Here we go. Let's share screen and hop back into this, gentlemen. Thank you very much. Number 12. Slide 12.

We'll jump to the Small Business Reorganization Act. This is just an absolute godsend for small businesses. As people have touched upon during the last hour, Chapter 11 traditionally can be time consuming and costly. This new law, the Small Business Reorganization Act, it streamlines Chapter 11 and makes it much more cost effective for small business. So what is a small business? We can go to the... It's at the bottom of this slide. The key metric is a debtor that has under seven and a half million dollars. That threshold used to just be 2.7 million dollars in change but recent legislation under the CARES Act, the Corona Aid Relief and Economic Security Act, bumped that threshold up, almost tripled it. It's a real godsend for small businesses that there is now this sub Chapter 5 within Chapter 11. If we can go to the next slide, Rick, I'll highlight some of the key differences between traditional Chapter 11 and this new sub Chapter 5, which are all good for business owners.

The first point: the Chapter 11 plan filing period is 90 days generally and you don't have to file a disclosure statement with your plan. A disclosure statement is a time consuming process and costs a significant amount of time and money to prepare. That's gone. That's great for the business owners. 90 days is also, in the world of bankruptcy, a real accelerated time period. Everybody, there's a heightened sense of urgency to get a plan filed quickly, which is good because that's going to keep the administrative cost down if you're not in bankruptcy for a long time.

The second point: a debtor can repay its debts over a three to five plan using disposable income, and there's, quote, no absolute priority rule. That's what I touched upon earlier in the cram down situation. In regular Chapter 11, if creditors aren't being paid in full the owners typically have to go out of pocket a significant amount to help fund the plan. Small business reorganization and sub Chapter 5, different ball game. The only threshold is over a three to five period. Are creditors getting paid with the company's disposal income? If the answer to that question's yes and that plan's confirmed the owner can emerge from bankruptcy continuing to own the company without going out of pocket. That's a huge win for the owners.

This is just [inaudible 00:45:59] pile on top of it. I don't know this stuff like you guys do, but this stuff, Chapter 5, sounds like an awesome and better situation for a small franchisee. All of a sudden I'm like, "Whoa. This is a million times better." Go talk to your lawyer.

Another huge benefit, just to piggyback on Rick's comment, a trustee, instead of having a creditors committee, which I haven't mentioned, there's just a trustee. A creditors committee in regular Chapter 11s, they serve as a watchdog for the unsecured creditors. But a lot of times they can be very obstructionist in terms of the debtor's efforts to get a plan confirmed to get an asset sale done. All that... what I'll characterize as obstructionistic behavior... runs out the cost of the case and it delays the case. Instead, you have a trustee that's appointed and the role of the trustee in sub Chapter 5 is really like a mediator. They want to see a plan confirmed and they will make suggestions, that they'll issue spot for the case, and then they'll encourage sides. "If you do this, I'm going to support the plan and not object to it." They kind of lead the horses to water, if you will, in terms of what needs to happen to get a plan approved. So having that trustee, unlike other cases, is a real valuable resource in a sub Chapter 5, Chapter 11.

What about timing here? Let's say we're not in COVID. I know that it's hard for us to step out of it. Does a sub Chapter 5 happen, on average, twice as fast as a Chapter 11? It sounds like it's a lot more expedient.

Because this is so new I would be... There's no data for me to objectively answer that, but it's going to happen two to three times faster, if not a higher multiple even. Some Chapter 11s go several years until they get their plan but we're talking a time period of three to six months for confirming a Chapter 11 plan and sub Chapter 5, whereas it's common for a case of bankruptcy to go a year or beyond before a Chapter 11 plan is confirmed.

That's really helpful.

A heightened efficiency. Finally, another benefit to the owner... and this gets to personal guarantees. If a debtor's owner mortgaged his or her primary residence as security for the business loan, the company debtor plan can modify that individual's mortgage loan as part of the bankruptcy. In regular Chapter 11 that can't happen. The individual owner would have to file his or her own separate bankruptcy and Chapter 7 or Chapter 13, or maybe a personal chapter, to get that done. Now it's streamlined. If the only reason the owner would ever even think about individual bankruptcy is just because of the stinking, rotten, nasty mortgage on their house, then they get to bake it into this small business sub Chapter 5. It's much more fair to the owner, much more concise. It's a real win.

Those are some of the highlights under sub Chapter 5. The bottom line is sub Chapter 5 is an absolute win for small businesses and their owners.

I'll burn through these last couple real quickly. In my experience in dealing with franchisors, what we're really concerned with... franchisors typically are concerned with... are damaged brand reputation and closure of units when it comes to a bankruptcy. We're in a headline reading society. People don't typically read the articles and if they do it's not well written or they don't understand what they're talking about. In this case, when they read so-and-so is in the bankruptcy, the immediate thought to a lot of people when they read that is, "That brand must be suffering in some way," without knowing the underlying facts such as death of an owner, a pandemic, you name it. It could be a whole laundry list of reasons why something is put into bankruptcy. Franchisors don't want that and franchisors make money by having more units. They don't want to see the royalty streams go away.

Notwithstanding the fact that your franchise agreement, your loan agreement, your lease, and your supply agreement, they all have the provision that if you file for bankruptcy it's a default under the document, the automatic stay would still apply. That provision is simply unenforceable in most cases because the fact that you're in bankruptcy, they still have to go to the court to approve. We can go to the next slide.

That's an important provision for sure.

All of those documents that everybody has signed with that language in it, the fact that you filed for bankruptcy, they're subject to the stay. The fact that language is there doesn't mean that the bankruptcy goes away. They still have to seek court approvals to go after their remedies. Franchisors normally know this and they want to work with you in a lot of the ways we discussed above to keep you out of bankruptcy when they can. Sometimes that just simply can't happen and you've got to go. But one thing to keep in mind when you're trying to make these decisions is, again, we're in a relationship business. I've had instances where clients went into bankruptcy; they did a good job of emerging. They did a good job. But that relationship with the franchisor was forever damaged because of the things we discussed above about loss of units and brand reputation. So they carried the scarlet letter B on their chest for the remaining time they were a franchisor until they were sold, and they ultimately had to sell because they didn't feel like they were wanted any more. While it can be a means to get out, it's not necessarily the end.

The final slide we have here, it goes to kind of the... If we can skip it... Just be prepared. Be proactive. Get in touch with your people. First and foremost, do not let problems sit. Deal with them on the front end. When you have problems and you let them sit bad things happen.

Yeah. I think that's probably the big takeaway here, is don't put your head in the sand. Seek professionals to help you if you're in trouble. And then you said it's a relationship-driven business, right Tom?


We want to be communicating with our lender and our landlords and our franchisor to alert them of problems before they happen and then we want to work out solutions as reasonable people and usually that can happen.

And one final thing on that. I think we oftentimes think of lenders, franchisors, landlords, suppliers as adversaries. One of the things that I've learned in this pandemic is that people are starting to get over that for the most part because they realize they need one another. It's much more symbiotic than people even realize in the beginning. We need to take every effort to keep those relationships positive when you can. You can't always. You're going to have disputes. But keeping the relationships open, honest, and positive is a good thing.

Thank you Tom, Andrew. Listening to this webinar, you can tell they're experts in their field. Here's their contact information. Obviously, feel free to reach out to them. We'll provide you with an email so that you can get a copy of this webinar. You can always reach out to any of us with questions if you're going through this process at all. Just thank you so much. Thank you Tom and Andrew. You guys did a great job. And many blessings to all of you watching this webinar. Let's stay positive and let's go them.

Great. Thank you Rick.

Thank you Rick.

Thank you all. Awesome. Take care.

Bye bye.

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