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    Out of the Ashes

  • While bankruptcy has its pitfalls, restaurant companies are increasingly finding that it also provides an opportunity for a fresh start.

    Friendly's CEO John Maguire says the company has streamlined the menu, initiated store upgrades, and rolled out an employee training program since it filed for Chapter 11 bankruptcy in 2011.

    Bankruptcy helps with cleaning up a debt-burdened balance sheet, she says. And it’s often used to set a brand up for a major turnaround or sale. It’s a fresh start. “The phoenix rises from the ashes,” Johnsen says. “Maybe this business just wasn’t quite right. So someone else comes in and the original owners lost money. That is difficult, but you’ve saved something in the economy that’s worth saving. That’s the whole goal.”

    But Johnsen warns that bankruptcy is far from easy. The legal fees can be oppressive, and it usually takes at least a year to complete the bankruptcy process. Those considering filing for bankruptcy, she says, should know exactly what it is they’re trying to accomplish up front.

    “What’s the end game here?” she says. “Are you trying to eliminate debt? Expand your business? Are you trying to sell it?”

    It’s also important to remember that bankruptcy isn’t always the only choice, she says. Some brands can still meet their restructuring goals outside of the courts.

    “Bankruptcy is a tool to use carefully to resolve very specific problems. It’s not for everybody,” says Andy Wiederhorn, CEO of Fatburger. “You run the risk of losing control of the process when the court and other creditors are involved.”

    Two Fatburger subsidiaries filed for Chapter 11 protection in 2009 as the company sought to transition from a majority of company-owned stores to nearly all franchised units. Real estate drove the restructuring, Wiederhorn says. Stores that were once in high-traffic areas had gradually dwindled as development moved away.

    “What used to be the most popular part of town is now an old part of town,” the CEO says. “The economics that may have originally worked didn’t work, given the sales levels in some of those locations. But we still had lease terms obligating us to stay there.”

    Wiederhorn points to a former Fatburger store at the Third Street Promenade in downtown Santa Monica, California. The store was renting the space for $13,000 a month, but through a lease renewal before the Great Recession the landlord demanded $34,000 a month, a number that Widerhorn says would never make economic sense. So the company broke the lease.

    The bankruptcy allowed Fatburger to close unprofitable stores, terminate unfavorable leases, and switch its focus from operating company-owned stores to supporting its franchisees. The brand has now grown from about 90 units to 150, a figure that includes 25 units of its sister chicken-wing concept Buffalo’s Cafe.

    “It’s a huge success story,” Wiederhorn says.

    But it’s also a story that he thinks would have been possible without bankruptcy, which racked up legal bills in the seven digits.

    “I can’t say we saved any money doing it that way. We may have spent more money going through bankruptcy, but we achieved the result we wanted,” Wiederhorn says. “I think in hindsight we could have achieved the same results at probably the same cost, because it was so expensive, honestly. I don’t know that we saved any real money in bankruptcy that we wouldn’t have spent if we’d just negotiated richer deals with our creditors.”

    Tom Mullaney, a founding partner of the real estate and financial restructuring firm Huntley, Mullaney, Spargo & Sullivan, says there are generally three problems that lead restaurant companies to seek bankruptcy: excessive past growth, use of large amounts of financial leverage, and concept deterioration. Bankruptcy is most used for those looking to solve problems with the balance sheet or real estate lease liability. Rarely do vendor contracts or labor costs push brands to bankruptcy, he says.

    Mullaney warns against counting on bankruptcy as a foolproof means to prepare a company for sale.

    “Clearly some folks use it with the idea to dress up a company for sale to a buyer,” he says. “But that’s easier said than done. By and large, when a company in the restaurant industry goes through bankruptcy, it’s a symbol of a multitude of problems. And it’s very hard to come back from bankruptcy.”

    But when things aren’t going well, when debt is piling up or a company is unable to make its loan payments, Mullaney says, it would be irresponsible to shy away from bankruptcy.

    “I would say the ‘B word,’ as we call it, has a pejorative connotation. And that’s the wrong way of looking at it,” he says. “Bankruptcy is simply a problem-solving mechanism. And it’s a legitimate problem-solving mechanism. When a company is facing growing storm clouds on the horizon, it would be corporate malpractice not to examine whether the bankruptcy code is the best and most efficient way of moving forward.”