“It has been said that, in many bankruptcy cases, there are no good alternatives, only less bad ones. As financial realities in this case took hold, it became clear that, for most creditors, including the objectors, there were not even “less bad” alternatives. The Court is saddened that it can offer only an explanation for what happened and why.” Judge Paul Bonapfel.
National fast food chain The Krystal Company (and several related entities) filed Chapter 11 Bankruptcy petitions on January 19, 2020 in the Northern District of Georgia. It was ultimately determined that the largest secured creditor, Wells Fargo, had a secured claim of $51 million and it was secured by a lien on virtually all of the Debtor’s assets. The Debtor, Creditors Committee and Wells Fargo agreed that the best way to pay creditors was to sell the Debtor’s assets as a going concern. After significant marketing efforts and failed proposals, the parties proposed a sale of the Debtor’s assets to DB KRST Investors, LLC, a sub-agent for Wells Fargo. The consideration paid for the Debtor’s assets included:
(1) reduction of the amount of the Wells Fargo debt by $ 27 million (leaving an unpaid claim of about $ 24 million); (2) assumption by DB KRST Investors of postpetition debts incurred in the ordinary course of business, including attorneys and other professionals employed by the Debtor and the Committee for their work in the case; (3) assumption of liabilities under certain leases and other agreements; and (4) use of cash to pay expenses necessary to pay postpetition obligations the Debtor had incurred during the case and to “wind down” the chapter 11 case.
Notably, there was essentially no money left for general unsecured creditors after the sale. After resolving some other matters in the case the Debtor filed a Motion to Dismiss the Chapter 11 case because there were no remaining assets and nothing more to do that could lead to payments to creditors. After notice of the Motion to all creditors the Court received several objections to the dismissal. Most were from individuals or small businesses who experienced hardship from the loss of their claim:
One person has lost the ability to feed poor people and help a high school student attend college because gift cards and a scholarship that the Debtor is obligated to provide under the terms of a settlement agreement for wrongful termination of employment will not be honored. Another individual has not been paid for services rendered in good faith in December 2019, right before the bankruptcy filing. A small business has lost about $ 18,700 for services rendered and expenses incurred that will not be paid. A customer injured at a Krystal restaurant has not received compensation for his injuries. Four workers who were laid off due to the Coronavirus pandemic are struggling to make ends meet for their families and have had difficulty receiving unemployment compensation. There are a lot of other people and companies with valid debts that the Debtor has not paid, and it is likely that many of them are suffering similar financial hardship…
Another creditor believed that failing to require the Debtor to pay it’s debts was a form of corporate welfare:
… Krystal [should] be required to pay its debts to us for this project. There has been too much corporate welfare in this country this summer to the gross detriment of small businesses and the American people. Krystal should not be a part of that – their marketing team and other high pay level execs still have jobs, their restaurants are still open. They should not be released from their moral and legal responsibilities when they still have the means to pay the debts to the small businesses who have worked hard and spent their own money for them. The small businesses who make this country what it is and without whom there would be no large corporations.
Judge Bonapfel discussed, in layman’s terms, why the case was dismissed without making the company pay creditors.
Why Should This Case Be Dismissed? A chapter 11 bankruptcy case can end in one of three ways: (1) confirmation (court approval) of a plan of reorganization for the payment of creditors; (2) conversion to a case under chapter 7 for the appointment of a trustee, liquidation of assets by the trustee, and distribution of the proceeds to creditors … ; or (3) dismissal. With no assets and no business, the Debtor cannot possibly propose a plan for reorganization. Conversion to chapter 7 would be futile. Again, the Debtor has no assets, so a chapter 7 case could not possibly result in any benefit to anyone. The only alternative, therefore, is to dismiss the case. Nothing can be accomplished in the bankruptcy case to produce any money to pay the objectors and other creditors…
Why Do the Bankruptcy Laws Permit This? A primary purpose of the bankruptcy laws is to preserve the going concern value of a distressed business in order to maximize payment to creditors. Preservation of going concern value also avoids loss of jobs that occurs when a company shuts down. Preservation of most of Krystal’s business is what happened in this case. Together, the sale and the related settlement of matters involving the Wells Fargo claim resulted in the preservation of the Krystal restaurant business as a going concern under new ownership and the realization of more value than would have occurred if its assets had been sold in piecemeal sales at each location. Although many employees lost jobs arising out of lay-offs during the pandemic or because some locations closed, many others continued to have employment.
In this case, the business (Krystal restaurants and sliders) was preserved and many employees kept their jobs, landlords were able to collect rent, suppliers were paid, and so on. “None of this, however, benefitted unsecured creditors like the objectors, who will receive no payment on their claims and have suffered as a result. Unfortunately, the bankruptcy system has no answer to this difficulty. The problem arises from the economic realities of the Debtor’s situation, not the way the bankruptcy laws work... In this case, the process worked for some parties, such as employees and landlords. The result for others, like the objectors, was a disaster. The point is that the disaster resulted from financial circumstances, not the operation of the bankruptcy laws.” Finally, Judge Bonapfel briefly addressed the “corporate welfare” objection, noting that the “old Krystal” was left with no assets and the owners lost their entire ownership interest in the company
Scott Riddle’s practice focuses on bankruptcy and reorganization. Scott has represented businesses and other parties in Chapter 11 cases for almost 30 years. You can contact Scott at 404-815-0164 or firstname.lastname@example.org. For more information, click here.
Image Credit: The Krystal Company