Navigating Troubled Times
By Tracy Green
[Originally published in The Wendel Report: Restaurants and Wineries, Winter 2009.]
These are difficult times for many of our clients. We are seeing talented restaurant owners face troubled financial times even though their operations are stellar. Good reviews and reputations do not make one immune to the impact of a troubled economy.
If you think there is a chance that you will not be able to keep the doors open, seek legal advice before making irreversible decisions that worsen your situation. If you have to shutdown a restaurant that you run as a corporation, you may be able to open a new restaurant later; however, if you leave the corporation with significant personal liability, it will be more difficult to start a new venture.
For example, if you use the withholding taxes you are supposed to pay to the IRS as a means of financing your business, even if it is inadvertent, you may be personally liable for that expense. I once had a client who thought he could use the withholding taxes for a short time, while he waited for a known and previously reliable investor to make a capital infusion in a few months. Unfortunately, the investor had an unexpected financial problem and could not come through with the funds. Suddenly the business had to shut down, and the owner had a large outstanding personal debt to the IRS. Also, those in the food industry should be careful to avoid PAC Aliens. PACA liens are statutory liens in favor of agricultural growers. The law allows those creditors to look to the individual owner for payment. A produce wholesaler suffered a sudden loss when an employee embezzled more than $1,000,000 from his operations. To make up for the loss, he used proceeds that were supposed to be paid to suppliers to pay the vendors who were entitled to a portion of the embezzled funds. He calculated that over a specific period, he would make enough profit to repay the suppliers and survive the disaster. However, the suppliers who did not get paid pushed the owner into an involuntary bankruptcy case, and that led to the company shutting down. The unpaid produce suppliers had PACA liens. The owner considered filing his own personal bankruptcy case; however, a personal bankruptcy would not have helped him because PACA liens are nondischargeable in a bankruptcy. This owner unwittingly turned a corporate debt into a personal debt.
When a business files a Chapter 7, the business shuts down immediately upon the filing of the petition. A trustee-inbankruptcy is appointed to liquidate the assets of the business. All of the corporate assets go into the bankruptcy case: tables and chairs, liquor license, secret recipe, etc. The trustee sells the assets for as much as he or she can and distributes the proceeds to the benefit of the creditors. In addition to selling the assets, the trustee looks for lawsuits to file, such as avoidance actions, to bring additional funds into the estate that will be distributed to unsecured creditors.
A Chapter 11 reorganization or liquidation is significantly more costly than a Chapter 7. However, the Chapter 11allows the debtor to stay in possession of its assets and continue to operate. The goal of a Chapter 11 is to have a plan or reorganization that is approved by the creditors and the court. The filing of a Chapter 11stops creditors from taking any action to sue the debtor, enforce a judgment or foreclose on an asset; however, reorganization requires the debtor to produce a plan regarding how it is going to emerge from the bankruptcy. The plan can be to continue operations and make payments to creditors over time, or the plan can be selling the restaurant and paying creditors from the proceeds. We had a client that used Chapter 11 to sell five restaurants to three people. The remaining stores were too unprofitable to survive with the leases in place, and they were closed. By breaking the leases in bankruptcy, the landlord’s claim was limited by statute, and the debtor paid the creditors out over time. The advantage of the Chapter 11 filing was that it allowed that debtor to stay open to maximize the value of the sales. This was important to the owners, who had personally guaranteed some of the liabilities.
Assignment for the Benefit of Creditors
If a restaurant has a willing buyer, or a short list of buyers who are interested in purchasing the restaurant, an Assignment for the Benefit of Creditors is an ideal way to sell a restaurant when there are insufficient funds to pay creditors in full. In an Assignment for the Benefit of Creditors, the restaurant assets and liabilities are assigned to a neutral third party who acts as the Assignee. The Assignee markets the restaurant and quickly sells it for as much as the market will bear. The creditors do not vote on the assignment or the sale, and the sale can be conducted within a week, if necessary, depending on many factors. Usually a sale is subject to overbid, and an auction can result. (In one recent assignment case, assets that were expected to be sold for $250,000were sold for $1,850,000 in an auction frenzy.) An Assignment can also be useful if a secured creditor wants to foreclose and conduct a public sale. By requiring a neutral party to conduct the sale, creditors are assured that the neutral party took the necessary steps to auction the assets for a sale price that was the best that could be obtained under the circumstances. An assignment does not work if a secured creditor is owed more than the amount of its debt, unless it consents to allow the assignee to sell the assets for less than the lien. After paying the secured creditors and liquidating the assets, the Assignee, like a Chapter 7 trustee in bankruptcy, distributes the proceeds to the creditors.
Out of Court Workouts
Last, some debtors find that they can reorganize by going through a formal Out of Court Workout. In this scenario, a neutral company is retained to act as a secretary. Notices are sent to all creditors inviting them to appear at a meeting to find out what is going on with the debtor. At the meeting the debtor explains why it is having trouble paying its creditors and asks the creditors to agree to a moratorium on collections. During the moratorium, the debtor meets with a committee that is formed, and discusses its plans for how it is going to pay creditors. Over some period of time, a plan is negotiated and circulated for a vote. The plan is only binding on those creditors who vote in favor of the plan.
If you liquidate or reorganize in the most effective manner, your skills and talents will allow you to undertake your next venture. Do not inhibit your ability to reorganize by inadvertently converting a corporate liability into a personal liability.