Anyone who has worked the back of the house at a popular restaurant knows how chaotic the kitchen can feel during a restaurant "rush" hour — line cooks and sous chefs furiously plating food and sending it out. The same intensity will also mark what the restaurant bankruptcy industry as a whole will experience in the remainder of 2020 through at least the middle of 2021.
But out of the haze of bankruptcy filings, there will be some golden opportunities for a savvy private-equity firm or other restaurant chains with an appetite for a good deal.
It should be noted that pre-COVID, restaurant chain Chapter 11 or 7 bankruptcy filings were on the rise despite a strong economy. In 2019 alone, companies seeking bankruptcy protection included Perkins, Houlihan's, Restaurants Unlimited (multiple locations including Kincaid's), Kona Grill, Granite City and the Palm. Over-competition caused in part by cheap money and relatively low barriers to entry helped fuel the bankruptcy uptick along with excessive bank debt to fund expansion; poor real estate locations or lease terms; an increase in delivery/e-commerce eroding restaurant margins; minimum-wage increases in several cities; and changing consumer tastes. Additionally, restaurants replaced retail tenants at many shopping centers and malls, resulting in fewer overall potential customers for the restaurants.
Even in pre-COVID 2020, at least five restaurant chains filed for bankruptcy protection. The fact that COVID-19 wasn't even on the radar two weeks before the wave of virus-related closures should be predictive of the additionally massive impact of these temporary closures.
The Paycheck Protection Program (PPP) helped slow the tide of failures among smaller chains, but for some, PPP money was really just prolonging the inevitable. COVID-19 has provided an additional untimely blow to the casual dining space that cannot transition as nimbly to a takeout-only model. Furthermore, as restaurants start to reopen — potentially more than once as several states have recoiled some of their earlier opening plans — casual-dining restaurants have to deal with reduced seating capacity in addition to a litany of other unfamiliar COVID-related requirements (providing and requiring personal protective equipment, and requiring reservations for seating).
In the interim, several restaurant companies are renegotiating (or trying to renegotiate) lease terms — most after missing April's rent payment at a minimum — as well as renegotiating their loan operating covenants. In my experience, banks are more sympathetic than landlords, perhaps because landlords have banks to deal with as well. Historically, landlords have generally been unflinching to threats of bankruptcy when dealing with delinquent tenants. Perhaps that will change with the realization that there may not be a lot of new tenants available. Candidly, financing new restaurant growth won't be very easy from either an equity or debt perspective.
So where does that leave us today? Some restaurant chains, such as those in the quick-service space, will continue to fare better. For other chains, such as those in the casual-dining space, bankruptcy may be the only option. Other than a fortunate buyer, there are few winners in a Chapter 7 filing.
Equity owners and landlords are on the losing end of this. Even secured creditors usually receive a pittance of their original investment; sales of used restaurant capital equipment were poor before COVID-19, so one can only imagine how abysmal they will be post-COVID.
For those restaurants with creditors willing to finance a bankruptcy, a Chapter 11 bankruptcy filing may be the only option. To be clear, a Chapter 11 is expensive — requiring teams of bankruptcy lawyers, "turnaround" management firms, and other professionals who all require secured and expensive payments upfront.
However, whatever the faults of the process, it is inevitable that there will be an onslaught of Chapter 11 filings for chain-restaurant companies in the balance of 2020 and likely through 2021.
On the positive side, for some prospective buyers, be they other restaurant companies or private-equity firms, there could be substantial opportunities to reject those costly pre-COVID leases for something more fitting for the new restaurant model regime. Restaurants, unlike brick-and-mortar retail, are not going away; people are social. We have to eat, after all.
Prospective buyers of distressed restaurant assets should start their legwork soon. There are myriad investment-banking firms available to help ferret out potential transactions. In my experience as counsel on such matters, these proceedings require a bit of work and a good measure of strategy, just as every chef will tell you that a good menu requires careful planning.
Doug Holod is a partner with Maslon LLP, Minneapolis. He primarily represents clients in technology/manufacturing and restaurant/retail.
