Mind Your Own Business: Unsecured Trade Creditors Receive More than Other Unsecured Creditors Under Applebee’s Franchisee’s Plan

Bankruptcy Judge Brendan L. Shannon recently confirmed the chapter 11 plan of RMH Franchise Holdings, Inc. and its affiliated debtors, notwithstanding that the plan proposed significantly better treatment for unsecured trade creditors than for other general unsecured creditors. RMH was formed in 2012 and, prior to its bankruptcy, had become the second-largest franchisee for Applebee’s restaurants in the U.S., according to its filings.

RMH and its affiliates filed chapter 11 cases in Delaware’s bankruptcy court on May 8, 2018.[1] On Sept. 20, 2018, the debtors filed their chapter 11 plan of reorganization, as amended, pursuant to which, vendors holding in the aggregate $1.4 million in unsecured trade claims would receive a 50 percent distribution on their allowed claims, while holders of general unsecured claims of about $42.3 million in total would receive only a 10 percent distribution on allowed claims.[2] The debtors’ plan went into effect on Dec. 21, 2018 (the “effective date”).

Necessary trade claims can have separate classification and treatment from other unsecured claims for a “‘reasonable purpose,’ legitimate basis, or necessary business objective.”[3] In their memorandum offered to support the plan, the debtors explained the different treatment of unsecured creditors by arguing that trade creditors would receive a greater distribution than other general unsecured creditors “in recognition of the fact that the Reorganized Debtors will require goods or services from the holders of such Trade Claims after the Effective Date.”[4]

The debtors argued that they would require goods and services from the holders of the trade claims to continue operations after the effective date of the plan, and cited case law from the Third Circuit Court of Appeals and other courts that have recognized that trade creditors may be treated differently than other unsecured creditors in such situations.[5] The debtors also highlighted the case of Nuverra Environmental, in which the district court affirmed the confirmation of the debtor’s plan despite the fact that an unsecured noteholder would receive a distribution of 4-6 percent and holders of trade claims would receive 100 percent, because “separate classification is necessary to maintain ongoing business relationships that the debtors need to ensure continuance of operations[.]”[6] The district court affirmed the confirmation order, finding “no error in the Bankruptcy Court’s determination that a rational basis for separate classification exists and that the classification was reasonable” because “the separate classification of trade creditors from noteholders foster[ed] the reorganization.”[7] RMH also cited courts in other jurisdictions that have reached similar conclusions.[8]

In RMH’s case specifically, RMH explained that the separate classification for trade claims was necessary to preserve the debtors’ trade credit with the vendors holding those claims. The debtors had to maintain their relationships with their vendors because many of the debtors’ restaurants operate in small towns with a limited number of vendors, and the debtors’ franchise agreements provided that only products designated and approved by Applebee’s, meeting uniform food and beverage specifications, as well as quality and appearance standards, could be sold at the restaurants.[9] RMH also indicated that smaller recoveries for the trade vendors could tarnish the debtors’ reputations and damage relationships with current vendors and hurt the debtors’ chances of developing business with other vendors in the future.[10] RMH emphasized that maintaining good relationships with trade vendors by providing them a better distribution would ensure the debtors’ continued access to the goods and services necessary for their continued operation on a going-forward basis, and that this constituted a significant business objective and legitimate and appropriate basis for the separate classification of trade claims under the plan.[11]

At the Dec. 11, 2018, confirmation hearing, the only plan objection remaining was that of the unsecured creditors’ committee.[12] Judge Shannon overruled the committee’s objection and confirmed the plan. In ruling in favor of plan confirmation, Judge Shannon emphasized that through months of “arduous” negotiations, the debtors achieved unlikely global settlements with Applebee’s, RMH’s parent company; ACON Franchise Holdings LLC, the plan sponsor and equity holder; and the senior lenders. At the hearing, Judge Shannon commended the debtors for their “significant and substantial achievement” in negotiating the settlements with the major stakeholders. Judge Shannon acknowledged that while not every stakeholder would be happy with its treatment under the plan, that was the nature of settlements.

Importantly, the debtors wanted to continue operating after confirmation of the plan, and Judge Shannon found that it would have been very difficult or extremely unlikely for the debtors to have done so without achieving the global settlements. Judge Shannon acknowledged that the exact distribution to the creditors might not have been ideal, but it provided a meaningful distribution to creditors, was acceptable to stakeholders, and provided the debtors with an opportunity to be capitalized moving forward and hopefully succeed on a post-confirmation basis. Without having struck the deals contained in the plan, the debtors would have been unlikely to succeed in obtaining confirmation of a plan, and even if they had obtained confirmation, they would have seriously struggled to capitalize themselves and move forward if it had continuing disputes with the secured lenders.

In reaching this decision, Judge Shannon emphasized the importance of the debtors’ desire to continue operations on a going-forward basis and noted that he was particularly concerned with the plight of the employees of the debtors, who would only continue to receive their weekly or monthly wages if the debtors succeeded. Judge Shannon seemed to be primarily focused on the fact that it had been exceptionally difficult for RMH to reach global settlements with the primary stakeholders and that those global settlements were almost necessary to the debtors’ successful reorganization. In RMH’s case, where the global settlements with RMH’s parent company, the plan sponsor and equityholder, and the senior lenders were necessary to continue the debtors’ operations on a going-forward basis, it appears that Judge Shannon agreed that the debtors had a legitimate justification for providing significantly higher distributions under the plan to trade creditors, this being necessary to the debtors’ continued operations.