Tough Talk: What Restaurants Need to Know and How General Counsel Can Help
5 Min Read By Michael Krueger
Owning and operating a restaurant is difficult under the best circumstances. So, what do we consider owning and operating a restaurant impacted by COVID-19? Challenging, but not impossible. As general counsel to over a dozen restaurants in the San Francisco Bay Area and Orange County, I have seen a lot of changes since the first shutdown orders came out in March. The role of general counsel during this unprecedented time is to ask the tough questions. How will the restaurant survive if seating capacity is reduced to 50 or 25 percent long term? How long can the restaurant keep staffing levels? When will the restaurant be able to repay past due rent obligations? How can the restaurant negotiate its debts and lease obligations? Is bankruptcy an option? Should we expand? Here are a few legal issues my clients are facing and how we are navigating those issues:
The role of general counsel during this unprecedented time is to ask the tough questions.
1. Workforce. Restaurants have had to cut a substantial amount of their workforce in response to COVID-19. The Paycheck Protection Program Loans (“PPP Loans”) were a great tool for what appeared to be a short term shut down. However, the PPP Loans were only a stop gap measure. Restaurants faced staffing issues when their workforce did not want to return to work once the restaurant received the PPP Loan for various reasons. Several staff members were furloughed only to be permanently laid off. However, that did not relieve the restaurant of its obligations to follow labor laws. Labor and employment claims will continue to be one of the top legal issues facing restaurants as they navigate the government health and safety regulations.
Several restaurants faced and continue to face staffing concerns due to the changing capacity regulations. Others have brought employees back that were only temporarily furloughed and have questions about accrued sick leave. The high turnover rate in the restaurant industry is just one of the reasons good record keeping and employee handbooks are so important, but they are especially critical now. They are also important tools available to general counsel to use to navigate their client’s employment related legal issues.
2. Rent. The top concern many restaurants will need general counsel services for is to advise them regarding their lease. A restaurant’s lease is a binding contract requiring them to pay rent for the restaurant space, much of which could not be used under the health and safety shutdowns. Many states, including California, anticipated a flood of evictions and have implemented moratoriums on evictions for tenants that have been harmed by COVID-19. The eviction moratorium is not a long-term solution. Instead, it is essentially a forced interest free loan to the restaurant from the landlord for the rent that would otherwise be paid during the moratorium period. Once the moratorium has been lifted the tenant must repay the past due rent over a twelve-month period. While that might sound like a good thing for the restaurant, in most circumstances it is unlikely a restaurant’s profit margins would afford the payment of current rent as well as an extra month’s rent. That is why general counsel should work with their clients and their respective landlords to negotiate forbearance agreements or renegotiate the leases now. It is important to remember that the landlord is impacted by COVID-19 as well and is motivated to work out a deal that works for both sides.
Not all restaurants should renegotiate their leases at this time. It is very important to review the new terms and conditions with the restaurant client to make sure it is in their best interest. For example, if the forbearance requires the restaurant owners sign a personal guaranty and the lease did not have a personal guaranty, the forbearance agreement may not be a good deal for the client. Another possible concern is regarding the extension of the term. If the restaurant cannot survive at a 25-percent indoor seating capacity cap, the restaurant is not going to benefit from an extended term of the lease. General counsel should explain all the restaurant client’s options within the lease, as well as review the COVID-19 state and local ordinances affecting the restaurant’s use.
3. Bankruptcy. There is a reason so many large chain restaurants are filing bankruptcy. It is unlikely large footprint indoor dining establishments will be able to re-open for regular operations by the end of 2021. That is not a typo. The end of 2021 is how far out restaurants that depend on indoor dining should plan for continued limited operations. General counsel should evaluate the restaurant’s assets and liabilities and create a plan to wind up operations. Restaurants typically have one asset that maintains value, its liquor license. In California, a liquor license transfer process is governed by the Alcoholic Beverage Control (ABC), which, among other things, requires a bulk sale notice to creditors and an escrow to distribute funds upon sale. Sometimes the sale of the liquor license is enough to satisfy all creditors and the restaurant dissolution is complete, but especially during COVID-19, we are seeing bankruptcy is the best option.
In 2019 the Small Business Reorganization Act (“SBRA”) was passed and added a new subsection to Chapter 11 of the Bankruptcy Code; and the CARES ACT, passed in 2020, increased the definition of a small business to include any business with less than $7,500,000 in debt. These two changes made Chapter 11 reorganization bankruptcy an option for a much larger group of restaurants. SBRA is a great option for restaurants to reorganize their debts and renegotiate their leases. If a restaurant is not likely to recover, even after reorganizing and renegotiating its debts, Chapter 7 bankruptcy may be the best option. Not to be outdone by the changes to SBRA on January 1, 2021 the homestead exemption, which allows a homeowner to exempt from their bankruptcy estate a certain value of their residence, increases from $100,000 to a minimum of $300,000 and a maximum of $600,000 in California. This is a huge change. Now a restaurant owner that personally guaranteed her restaurant’s lease could file Chapter 7 bankruptcy and keep between $300,000 and $600,000 in equity in her personal residence and walk away from all other obligations of the restaurant. That is just one of the reasons general counsel should be well versed in bankruptcy law or engage outside bankruptcy counsel.
Light on the Horizon: Evolving the Restaurant Model
Even though the previous sections discussed general counsel’s role in navigating the challenges many restaurants are going through, general counsel also play a critical role in restaurants that are able to take advantage of the current climate for expansion or transitioning to a ghost kitchen or quick service restaurant (QSR) model. Ghost kitchen models, where the restaurant utilizes a kitchen and delivery or take out model only, relies on embracing food delivery apps or other food delivery models.
The key to the success to most of these restaurants is eliminating the need for dine-in services and maximizing limited menu item and bar sales Many restaurants generate at least 30 percent of their total sales from alcohol and the impact California’s ABC easing of the restrictions on take-out and delivery alcohol sales had on these restaurants cannot be overstated. There are many nuances to a ghost kitchen lease and general counsel must be prepared to review and turn around the lease changes quickly as competition for these spaces continues to rise.
The role of general counsel during COVID-19 is to be informed of all of the changing regulations impacting the restaurant industry and advise the restaurant client of its options. COVID-19 is not going away any time soon and neither are restaurants.