Recent restaurant bankruptcies have shown just how quickly financial trouble at the corporate level can ripple across an entire franchise system.
Red Lobster, Rubio’s Coastal Grill, and other restaurant companies have gone through bankruptcy proceedings in recent years. More recently, FAT Brands, the parent company of 18 restaurant brands and a system of approximately 2,200 locations and 670 franchise partners worldwide, filed for bankruptcy in January.
For restaurant operators, franchisees, landlords, and suppliers, the important question is often not simply whether a restaurant company files for bankruptcy. It is what happens next.
A bankruptcy filing does not necessarily mean every restaurant closes or every brand disappears. A company may restructure, sell individual concepts or assets, transfer certain agreements to new owners, or reject contracts it no longer intends to perform. As a result, different pieces of the same restaurant system can have very different outcomes.
Businesses tied to a distressed restaurant company should evaluate those possibilities early.
A buyer may not inherit everything
One of the biggest misconceptions surrounding a restaurant bankruptcy is that when a brand or group of restaurants is sold, the buyer simply steps into the shoes of the previous owner. That assumption is often wrong.
The Bankruptcy Code allows a buyer to acquire selected assets, including restaurant brands, intellectual property, and certain contracts, free and clear of many prior claims and obligations, provided the court approves the sale and specific legal conditions are met. The scope of what a buyer assumes depends on the purchase agreement and the court’s sale order.
That distinction matters throughout a franchise system. A buyer may want the brand and its strongest locations without taking on every existing agreement or financial obligation.
The sale agreement and bankruptcy court order ultimately determine what is transferring. Stakeholders should not assume that a new owner will honor every obligation simply because the brand continues operating.
Franchisees need to know where their agreements stand
For a franchisee, the continued existence of the brand does not mean business will continue as usual.
Franchise agreements are generally treated as “executory contracts” under the Bankruptcy Code, which means the company may have the option to keep the agreement, transfer it to a buyer, or reject it through the bankruptcy process. Before keeping or transferring a franchise agreement, the company must address any existing defaults, typically by paying what is owed, and show the court that whoever takes over the agreement can perform going forward.
Those decisions can affect some of the most fundamental elements of a franchisee’s business, including its right to operate under the brand, royalty and advertising obligations, access to operating systems and approved suppliers, and territorial or development rights.
Brand and trademark rights can become particularly complicated when a franchise agreement is rejected through the bankruptcy process. A franchisee may still have certain rights after rejection, but whether it can continue using the brand, and under what terms, can depend on the agreement and circumstances of the case. Franchisees should not assume that rejection automatically ends every right under their agreement.
In some cases, a franchisee whose agreement is rejected may have the right to continue using the brand’s intellectual property, such as trademarks and operating systems, for the remaining term of the agreement, provided the franchisee continues making required royalty payments. Whether this protection applies depends on how the franchise agreement is structured and the jurisdiction. Franchisees should evaluate this option with experienced bankruptcy counsel.
That makes it important for franchisees to review both their agreements and bankruptcy notices as soon as a filing occurs rather than waiting to see whether their restaurant continues operating.
Franchisees should also pay close attention to cure amounts, which are the amounts the debtor says must be paid or otherwise resolved before an agreement can be assumed or transferred to a buyer. Disputes can arise over what must be paid or otherwise addressed before that can happen. The deadlines to challenge those amounts can be short.
A restaurant’s lease can determine whether a location survives
In restaurant bankruptcy cases, real estate can be one of the biggest factors separating locations that survive from those that do not.
A company may have a strong brand but a portfolio that includes underperforming restaurants, expensive leases, or locations that no longer fit its strategy. Bankruptcy gives a debtor an opportunity to evaluate those leases and decide which ones are worth keeping.
If a lease is transferred to a new operator, existing defaults must be addressed and the new tenant must demonstrate that it can meet the lease obligations going forward. Shopping center landlords have additional protections: before a lease in a shopping center can be transferred to a new operator, the court must be satisfied that the assignment will not disrupt the center’s tenant mix, violate use restrictions, or breach exclusivity provisions.
If a lease is rejected, however, the restaurant may lose the right to continue operating at that location and the landlord may be left with a claim against the bankruptcy estate. That claim, however, is capped by law. A landlord’s damages for early lease termination through bankruptcy are generally limited to roughly one year of rent (or a formula based on the remaining lease term), plus any unpaid rent owed as of the filing date. Landlords should factor this cap into their assessment of exposure.
For landlords, this means the financial condition of the potential new operator can matter just as much as the identity of the brand. They should pay close attention to proposed lease assignments, cure amounts, and the operational qualifications of any buyer.
It is a reminder to operators and franchisees that a brand surviving bankruptcy does not guarantee that every restaurant bearing its name will survive with it.
Suppliers face a different set of questions
Vendors can find themselves in a particularly difficult position when a restaurant company files for bankruptcy. They may already be owed money while simultaneously being asked to continue supplying food, equipment, or other goods necessary to keep restaurants operating. The timing of those transactions matters.
Goods received by the restaurant company in the ordinary course of business within 20 days before the bankruptcy filing may qualify for priority payment ahead of other unsecured creditors. Suppliers may also have the right to reclaim goods received by the company while it was insolvent, provided the supplier makes a written demand within the time frame set by law.
Payments received before bankruptcy can sometimes face scrutiny as potential preferences. Payments made within 90 days before filing (or one year, if the supplier is considered an insider) on account of earlier debts can be clawed back by the bankruptcy estate. Defenses exist — for example, payments made in the ordinary course of business are often protected — but suppliers who received large or unusual payments during this window should review them with counsel.
For suppliers, the key is to distinguish between what the company owed before filing and what it is asking them to provide after the bankruptcy begins. Suppliers asked to continue deliveries after a bankruptcy filing should carefully evaluate payment terms and consider seeking current payment or other assurances before extending additional credit.
Goods and services provided to the company after it files for bankruptcy generally carry priority status, meaning the supplier must be paid in full before the case concludes. Courts also frequently authorize the company to pay certain pre-bankruptcy debts to critical vendors whose continued supply is necessary to keep restaurants operating. Suppliers in this position have more leverage than they might expect.
What restaurant stakeholders should watch
Restaurant bankruptcies can move quickly, particularly when a company is pursuing a sale intended to preserve operating value and operations.
Franchisees, landlords, suppliers, and other stakeholders should immediately determine what contracts govern their relationship with the company, how much they are owed, and what deadlines apply in the bankruptcy case.
They should also closely review proposed sale documents. A restaurant brand being sold can make headlines, but the more consequential question for an individual operator may be whether that operator’s specific franchise agreement, lease, or other contract is included in the transaction.
The same applies to cure notices, claim deadlines, and objections. Missing a deadline can significantly limit the options available later.
Stakeholders should prepare for more than one possible outcome. A brand may be sold intact, individual locations may change hands, contracts may be rejected, or a concept may ultimately disappear.
Bankruptcy does not automatically spell the end of a restaurant brand. In many cases, the process is designed to preserve the portions of a business that still have value. But when a restaurant empire begins to unravel, the outcome can look very different depending on where you sit within the system.
Franchisees, landlords, and suppliers who identify their rights, deadlines and exposure before a transaction closes will be positioned to protect their interests. Those who wait will have fewer options.
Author Bio:
Michael J. Niles is a partner at Berger Singerman Florida’s Business Law Firm. Based out of Tallahassee, he is a member of the firm’s Business Reorganization Team and focuses his practice on commercial bankruptcy, creditors’ rights, and distressed business matters.
