New York Financial Crisis’ Affect on NYC Restaurants and Bankruptcy Options

A recent article on MSNBC (NYC restaurants slammed by financial crisis) details the problems currently faced by NYC restaurants. NYC restaurant owners are reporting a significant drop in business in wake of the recent financial crisis. They also have some of the highest rent in the country for space, and face high food, employee, and insurance costs. Faced with a significant drop in revenue, restaurant owners may not survive if they continue to do “business as usual” and will need to adapt to changing market conditions. In exploring their options, restaurant owners and investors should consider all available options, including the bankruptcy restructuring options that are the focus of this blog post. Bankruptcy is not a panacea and is something to consider when other options (such as obtaining additional investment, consolidation of space, altering menus and pricing, etc.) have been fully explored. However, bankruptcy presents some useful tools to NYC restaurant owners and investors that need to be understood.

1. Ability to Sell Below Market Lease Without Landlord Consent.

Often a below market lease in New York City may be one of a restaurant’s most valuable tangible assets. Most commercial leases in NY contain extensive restrictions on a tenant’s ability to sell or sublet space. In bankruptcy, however, a debtor in possession (in a chapter 11 reorganization or liquidation case) or trustee in a (chapter 7 liquidation case) has the ability to “assume and assign” a lease even though the landlord does not agree. The right to do this is not absolute and the replacement tenant must be able to establish an adequate ability to perform under the lease. In addition, defaults under the lease must be cured (or adequate assurance of prompt cure provided) in connection with any sale of the lease. The key point is that in a bankruptcy it may be possible for the value in the lease to be realized even if the tenant is in default under the lease and has been sued for nonpayment of rent (as long as the lease has not yet been terminated). Utilizing this option may allow an unprofitable restaurant to move to another location with cheaper rent where is could be profitable.

2. Ability to Reject Long Term Lease and Cap Damages.

If a restaurant is in an unfavorable location, either because rents are too high or there is not anticipated customer traffic, a lease can be rejected in a bankruptcy proceeding. The landlord’s rejection damages claim is capped in bankruptcy, under a formula that limits the claim (which is particularly useful in the case of a long term lease). Outside of bankruptcy a lease rejection damage claim might be the largest claim against a restaurant, but in bankruptcy such claim subject to the cap in the Bankruptcy Code on rejection damages would be significantly limited. As part of a chapter 11 reorganization case a restaurant could reject an unprofitable lease — and cap the rejection damages claim — and relocate to a more favorable location.

3. Ability to Reject Executory Contracts & Leases.

In addition to real estate leases, many restaurants have other long term leases, such as of kitchen equipment, and other ongoing commitments, such as employment agreements with chefs, management companies, etc. As part of a bankruptcy these ongoing contractual obligations can also be rejected. If two restaurants, for example, decided to merge operations to consolidate financial resources and reduce expenditures in a shrinking market, a bankruptcy proceeding could be used to reject burdensome ongoing commitments, such as equipment leases and employment agreements.

If you are interested in scheduling an appointment to learn more bankruptcy alternatives and how these may be utilized for a NYC restaurant please feel free to contact Stephen Z. Starr at 888-867-8165.