Small Business Reorganization Act and Subchapter 5 offers safety net for struggling restaurant franchisors

The Small Business Reorganization Act, passed in 2019 and first implemented in 2020, promised to provide small business owners with a more feasible, efficient, and less expensive way to restructure debt and move forward the operations of their business.

We’ve written previously about the details of the act, which implemented “Subchapter 5” of the Bankruptcy Code, here and here. As part of Congress’ COVID relief packages, the debt limit for small businesses to use Subchapter 5 was increased to $7.5 million through the end of March 2022.

For some small businesses, the option could not have come at a better time; the federal money and relief supplied by the government over the past nearly two years has not been enough to keep some businesses afloat. A recent bankruptcy case in Colorado involving a small restaurant franchisor provides a good example of how the Small Business Reorganization Act offers the perfect restructuring option for small businesses.

The case involved Lost Cajun Enterprises, LLC, a franchisor of Lost Cajun Restaurants. Before COVID shut down operations in the spring of 2020, the company had 30 franchised restaurants and more planned to open. In re The Lost Cajun Enterprises, LLC, Case No. 21-12072 (Bankr. D. Colo. Nov. 5, 2021). The franchisor also ran a related spice company. Because of the COVID pandemic, however, five of these restaurants closed, and a few more gave notice that they intended to close within a few months.

Lost Cajun Enterprises attempted to stay afloat by cutting overhead costs, obtaining Paycheck Protection Program loans, and attempting to negotiate a settlement with a former member of the business, but the combination of the pandemic’s effect on the restaurant industry and the dispute with the member caused the company to file bankruptcy under Subchapter 5 of the Bankruptcy Code in April 2021. Lost Cajun Enterprises had assets of approximately $340,000 and liabilities of approximately $1,450,000, including a Small Business Administration Act loan, a Paycheck Protection Loan Program loan, various debts from franchise operations, and a debt to their former member, Jonathan Epsey, in the amount of $651,000.

By June of 2021, Lost Cajun Enterprises filed a Subchapter 5 plan, noting that it would pay its secured creditor in full from current cash, and that unsecured creditors would receive their pro rata shares of their allowed claims over three years using the company’s disposable income – an approximately 12.75% distribution to unsecured creditors. The founding member would also make an equity contribution equal to the company’s disposable income projections to help pay creditors.

Epsey, the former member, objected to the plan and filed his own competing plan, disagreeing with the company’s characterization of the membership dispute and forward-looking financial projections. The court took testimony from both the company and Epsey during the confirmation hearing, but the Court ultimately approved the company’s Subchapter 5 plan, finding that:

• The plan was proposed in good faith under 11 U.S.C. § 1129(a)(3)
  • The company filed the case because it was unable to pay its debts as they came due because of the pandemic.
  • The company did not abuse the reorganization process.
  • While Epsy would not be paid in full, his unsecured claim would be treated the same as other unsecured creditors.
  • 2/3 in amount and more than one half in number of the creditors voted to accept the plan.
• The plan was in the best interests of creditors; although unsecured creditors would only receive a 12% distribution under the plan, Epsey did not provide a competing set of projections.
• The plan was fair and equitable. The Company had sufficient disposable income to pay its secured creditor and pay a distribution to its unsecured creditors over time.

The Court confirmed the plan, noting that Epsey was a “single, disgruntled creditor” and the case “is emblematic of how the Subchapter 5 statute was intended to operate with a one-step plan confirmation process.”

Overall – notwithstanding a major dispute with a former owner, a pandemic, and a struggling restaurant franchise – Lost Cajun Enterprises was able to be in and out of bankruptcy in about six months. The owners still have equity in the business, their dispute with the former owner is resolved, and they have a plan to pay their creditors over time. 

The Small Business Reorganization Act and Subchapter 5 provides a feasible, affordable option for restructuring a small business during these uncertain times. 

Attorneys at McDonald Hopkins are happy to help your business consider this or another option if your business is struggling.