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Billionaire John Kluge’s Metromedia Company owns casual dining giant Metromedia Restaurant Group Inc., which carries such chains as Ponderosa, Bonanza Steak House, Bennigan’s, Steak & Ale and others. Metromedia Restaurant Group filed Chapter 7 for S&A Restaurants Corp., the holding company for Bennigan’s and Steak & Ale.
Silent shareholder Atalaya Capital Management LP stepped into the fray upon the filing of Chapter 7, which sparked the firm to exercise their vote. Atalaya decided to step in and try to salvage the franchise part of the chain. It voted out the board of directors of Bennigan’s Franchising Company LP just before parent company S&A Restaurant Corp. filed Chapter 7. Atalaya then hired CRG Partners Group LLC to help turn the remaining chain around. CRG has been working hard with franchise owners to keep them running.
Firms Cannot Be Franchisors without Owning Franchise Rights and Trademarks
What company claims the rights to the intellectual property rights of the franchise chain and how secure are they?Alex Stockham, Vice President for Rubenstein Associates and spokesperson for Bennigan’s Franchising Company LP, confirms that the franchise agreement and royalty rights are intact and have been saved from bankruptcy. “Bennigan’s Franchising Company and Steak & Ale Franchising Company have the franchising agreement assets," he says. “Those are not part of the filing of Chapter 7. They are still subsidiaries of S & A Restaurant Corp., but they were not part of the filing. They weren’t part of the filing on July 29.”
Bennigan’s Franchising Company LP, the company that holds the franchise agreement assets, did not file Chapter 7 on July 29, although its parent and affiliated companies did. And twin company S&A Franchising Company LP has the franchise agreement rights to be the franchisor for the Steak & Ale franchises.
Besides the ability to franchise and receive royalties, there is also the matter of controlling the trademarks. But not quite three weeks before filing bankruptcy, Metromedia on July 10 moved to be a secured creditor of the Bennigan’s trademarks that S&A Restaurant Corp. held.
Stockham confirms that Metromedia Company moved to become a secured creditor of the trademarks on July 10. But he also gives reassurance to franchise owners. “The franchisor [Bennigan’s Franchising] has the exclusive rights to use the trademarks for restaurant operations and in franchising," he says. "Those trademarks are also collateral for the Atalaya lending facility.”
In Bankruptcy, Firms Cannot Cherry-Pick Companies to Leave Behind the Lemons
Professor Jack Williams, a bankruptcy and tax attorney and resident scholar at the American Bankruptcy Institute, thinks that franchise owners should not take for granted that their old franchisor will continue to have the ability to franchise. He observes, “Once the bankruptcy case is on the horizon, Congress has made a determination that companies cannot take activity to opt out of the collective process that is looming. For a company that is getting ready to file bankruptcy, the bankruptcy code generally doesn’t allow them to cherry-pick assets and leave behind a carcass.”
Robert Zinman, a bankruptcy scholar at St. John’s University and past president and chair of the American Bankruptcy Institute, also stresses that companies cannot cherry-pick. “An entity filing in bankruptcy cannot pick and choose which of its assets are affected by the bankruptcy,” he states.
One sign of suspicious activity is the timing of secured credits and asset transfers. For example, nineteen days before it filed Chapter 7 to liquidate the holder of the trademarks, S&A Restaurant Corp., Metromedia became a secured creditor of the Bennigan’s trademark.
The Trademark Trail
Philip Furgang, a well-known intellectual property rights and franchise lawyer with Furgang & Adwar LLP, recaps what Metromedia Company did. “S&A Restaurant Corp. made an assignment to Fortress Credit Opportunities LP of a security interest in the marks,” he states. “What that generally should mean, if properly drawn, is that S&A retained ownership and Fortress secured the loan based on the asset value of the trademarks in 2003. Then, on July 10, 2008, S&A assigned its trademark rights to Metromedia. There appears to have been no recorded reassignment of the security interest back to Fortress, so Fortress may still be a creditor.”
Furgang reiterates that in bankruptcy it is important to look at the sequence of corporate events. “There may be an issue of fraud on creditors given the short space of time between the assignment and the bankruptcy filing,” he states.
Are Bennigan’s Franchisor’s Rights Solid? The Technical Legal Arguments
Williams, considered as one of the top scholars on bankruptcy in the country, agrees with Furgang’s assessment of watching the timing of transfers when a company files bankruptcy. He is particularly suspicious of the timing of the S&A Restaurant Corp. transfers of trademarks, as well as how it has tried to insulate its franchise agreements.
“The Bennigan’s situation looks like a very clever attempt to bankruptcy proof the franchise agreements and ownership of the trademarks,” thinks Williams. "The question is going to be whether this clever attempt will hold water at the end of the day, if and when parties start challenging and closely scrutinizing those relationships.”
Some close to this disagree with Professor Williams’s conclusions. They point out that first and foremost, Bennigan’s franchisor is not under bankruptcy proceedings. Its trademarks are currently not for sale. They believe that Bennigan’s is not at risk of losing the right to use the brand markings because the court is not in a position to make "substantive consolidation," a legal action when courts pool two or more debtors into a single pool to pay creditors. They remind us that such a move is a highly unusual remedy by the court.
A basic problem with applying a theory of substantive consolidation is that it is highly unfair and prejudicial to creditors of the franchisor because creditors relied on having separate collateral when they made their loans.
Williams agrees that the substantive consolidation argument would not bring much traction with the bankruptcy court. “There is no risk that debtors and non-debtors would be substantively consolidated for the reasons given,” he declares. “My tentative theory rests on fraudulent transfer law and not substantive consolidation."
Still, Tom Pitegoff, a New York franchise attorney, cautions about thinking that Metromedia is in danger of losing the trademarks and franchising rights. He states, “The trademarks are owned by S&A, which presumably has an intercompany license agreement allowing Bennigan's Franchising to use the trademarks. A company called Fortress Credit Opportunities appears to have held a security interest in the trademarks. Just before the Chapter 7 filing, this security interest appears to have been transferred to Metromedia Company, which I understand was the indirect owner of S&A [Restaurant Corp.].
Presumably, Metromedia has or will exercise its right as a secured creditor to become the transferee of both the trademarks and the intercompany license agreement to satisfy any debt from Bennigan's Franchising to Metromedia,“ continues Pitegoff. “Because the trademarks and the franchise agreements themselves are not the subject of the bankruptcy, it is doubtful that any group of franchisees will have the opportunity to acquire the trademarks in the way that Ground Round franchisees did some years ago.”
Williams thinks that the trustee may not see it this way. “The royalties on the franchise side are receivables,” argues Williams. The trademark value is in its licensing ability so it is essentially a receivable. What Metromedia has done is establish entities to possibly house these intangible assets to limit the effect of any bankruptcy filing by any operating entity.”
Possible Next Steps
Williams advocates, “The fraudulent transfer analysis is completely different than a substantive consolidation analysis.”
“I would suggest that a trustee investigate who originally owned the royalty rights and trademarks, have they been transferred or assigned to other entities, when, and how did those rights get housed in the present entities,” states Williams. “I would then apply Bankruptcy Code section 548 and the Texas Uniform Fraudulent Transfer Act to see if any transfer existed, the value of what was transferred, what was received in exchange for the rights transferred, whether the transferor was insolvent, etc.”
Listed below are key relevant bankruptcy codes that Williams seems to have memorized and thinks may apply to the Bennigan's case:
“The creation of a security interest and its perfections are both transfers under the bankruptcy code,” says Williams.
A member of the Texas bar, Williams states, “Management’s decisions about what entities to put into bankruptcy and what entities not to is presumed to be a valid exercise of business judgment.”
Bankruptcy scholar Zinman agrees. He emphasizes that in a family of companies, just because a holding company files Chapter 7 does not mean that other associated companies in the family have to file bankruptcy. “If an entity files in bankruptcy and its subsidiary does not, generally only the [filing] entity and its assets could be governed by the bankruptcy, not the assets of the subsidiary,” Zinman says. “The stock of the subsidiary is an asset of the filing entity and could not be cherry-picked away. This is assuming the subsidiary is a valid subsidiary and there is no basis for attacking or otherwise dealing with the corporate entity or avoiding any of the agreements or actions they have taken. There are provisions in the bankruptcy code that might be available to do such things if the right circumstances exist.”
Still, Williams suggests that there may be more at play here. “Not withstanding the acknowledgment that management can make decisions of what entity files for bankruptcy and what entity does not,” he says, “the question is whether the creditors can somehow trace or challenge or otherwise recover assets that are in those entities that are outside the bankruptcy sub-family.”
Has Metromedia positioned itself to inherit trademarks without a challenge from the bankruptcy court?
Williams's own take is that the situation looks curious.
“This appears like it could be from a page out of a 1990s or early 2000s playbook in the area of the securitization of accounts receivable," he observes. "This is very creative bankruptcy ‘lawyering.' But sometimes you can be too clever by half. Some of those business structures back at the turn of the century were successful in immunizing assets from the bankruptcy court: Many were not. That’s the question here, whether the cleverness aside, this will hold water once you amass that huge arsenal that a Chapter 7 trustee has in a bankruptcy case to elevate substance over form."
But because things look strange does not necessarily mean that there was ill intent or an avoidable transfer. Williams provides this caveat, “Of course at the end of the day there may not be any avoidable transfer, but who knows until at least a preliminary investigation is undertaken.”
Meanwhile, the franchise owners are under the impression that their franchisor, Bennigan’s Franchising Company LP, is here to stay and in firm control of the trademarks and the rights to their royalties. Larry Briski, an Indiana franchise owner and chair of Bennigan’s independent franchise owners association, declares that this is not a concern of franchise owners for the moment. Briski says, “I’m assured that the franchise agreements and trademarks have strong legal protection. We have employed a franchise attorney early on to work for the interests of our owners.” The franchisees hired James Rothschild, a mergers, acquisitions and divestitures attorney with Shumaker, Loop & Kendrick LLP in Toledo, Ohio.