The restaurant industry is no stranger to hardship - particularly evident in recent years - having faced mandatory closings, reduced occupancy requirements, labor shortages, and increased labor costs as a result, and various other operational challenges resulting from the Covid-19 pandemic. For these reasons, many restaurants have decided to explore Chapter 11 to obtain much-needed debt relief.
A discussion of restaurant bankruptcies ought to begin with a discussion of bankruptcy exit strategies. The most successful restaurant reorganizations are most likely to occur when debtors, guided by experienced counsel, have analyzed their exit options before filing their bankruptcy petitions. Planning is, indeed, key.
Prepetition planning is important because of the limited time debtors have to decide if they want to retain leases, sell assets, or reorganize. For example, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) imposes a limit of 210 days from the date of the petition for a debtor to assume or reject its storefront lease. Moreover, if considering a liquidation, debtors must understand their liquidity position and debt covenants, including the lender's rights pursuant to a loan agreement. This prepetition planning allows a debtor to isolate areas of potential contention and tackle them upfront, which will ultimately reduce costs and ensure a smoother road through the bankruptcy process to the goal of confirmation of a reorganization plan.
Chapter 11 provides many benefits and protections to debtors. The most significant of these available protections include the automatic stay, which prohibits collection and enforcement activities against the debtor. The automatic stay means that a creditor cannot evict the debtor from its leased premises or enforce a prepetition judgment against it. Lease rejection is another benefit. The debtor possesses the ability to reject contracts and leases that are unprofitable or burdensome. The threat of rejection can be used as leverage to negotiate more favorable terms with the debtor's landlord.
While advantageous, Chapter 11 bankruptcies are not without challenges. Chapter 11 is more costly than an out-of-court workout. Management also risks being displaced by the appointment of a Chapter 11 operating trustee. The debtor must also seek court approval for all decisions outside the ordinary course of business, such as the rejection of material contracts. A debtor may additionally face a lack of available financing. A lack of post-petition liquidity may prevent a debtor from successfully reorganizing. This is why prepetition planning, such as maximizing use of a debtor's borrowing base on prepetition loans is important.
A smooth transition into Chapter 11 usually requires filing first day motions to seek the relief necessary to address both administrative and operations issues. First day motions accomplish restoring confidence of trade suppliers, maintaining employee morale, and minimizing the impact of the filing on business operations. With respect to boosting employee morale, a debtor can plan the filing to minimize the amount of prepetition wages owed to employees. For example, filing the petition at the onset of a given payroll cycle will ensure employees receive wages for work performed prepetition.
As a final note, trade creditors should be aware of the protections available to them under the Bankruptcy Code to maximize recovery on their claims. Trade creditors should consider their possible status as critical vendors or letters of credit to support payment obligations, to name a few.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
