February 7, 2020 − SD-Charlotte, LLC and four affiliated Debtors (together, the “Debtors,” each separately and privately held) filed for Chapter 11 protection with the U.S. Bankruptcy Court in the Western District of North Carolina, lead case number 20-30149. The Debtors, who collectively own and operate approximately 90 franchised restaurants in the Southeast United States (eg, Sonic Drive-In and MOD Pizza restaurants), are represented by Zachary H. Smith of Moore & Van Allen PLLC. Further board-authorized engagements include (i) JD Thompson Law as bankruptcy counsel, (ii) MERU LLC as financial advisor and (ii) Stretto as claims agent.
Each of the Debtors (see structure chart below) is majority owned by Yaron Pinhas Goldman (“Mr. Goldman”).
The Debtors’ lead petition notes between 200 and 1,000 creditors; estimated assets between $1.0mn and $10.0mn; and estimated liabilities between $1.0mn and $10.0mn. Documents filed with the Court list the Debtors’ three largest unsecured creditors as (i) Sonic Industries ($3.8mn trade debt), (ii) Itria Ventures LLC ($2.5mn disputed factoring agreement) and (iii) Libertas Funding, LLC ($1.9mn disputed factoring agreement).
Events Leading to the Chapter 11 Filing
In a declaration in support of the Chapter 11 filing (the “Declaration”), Brian Rosenthal, a principal with the Debtors' financial advisor (MERU), detailed the events leading to SD’s Chapter 11 filings. Mr Rosenthal details what will undoubtedly make for hushed presentations at future conventions of Sonic (and other) franchisees, a cautionary tale of rapid expansion; aggressive, leveraged and expensive borrowing; and sloppy management; the latter resulting, inter alia, in (i) an "unexpected" $7.0mn capital gains tax bill (who knew that a sale-leaseback transaction could result in a capital gain?) and (ii) a failed sale effort due to the discovery of "UCC-1 financing statements filed in favor of parties other than the Prepetition Secured Lender." Always hard to sell an asset that isn't actually yours.
Other lessons to be taught by the current Debtors relate to merchant cash agreements ("MCAs," the counterparties to those agreements now featuring super-sized in the Debtors' list of top unsecured creditors), with the Debtors turning to extremely expensive sources of financing…all other doors to capital having been shut. The Declaration notes that in 2019 "the Debtors sold no less than $7,988,325 of future accounts receivable to the MCA Parties in exchange for cash payments in an amount not less than $5,880,000, less fees and certain expenses." It hard not to wonder at the "not less than…, less fees…" construct; but with or without fees, clearly very expensive borrowing. Unless of course one files Chapter 11 and does not pay it back; and clearly some of these MCAs were entered well after the Debtors were looking at their "strategic alternatives."
The Declaration provides: "According to Mr Goldman….From 1999 to 2015, SD Holdings developed and acquired over 60 McAlister’s Deli franchise locations, which SD Holdings eventually sold in 2016 and 2017. Mr. Goldman, who began his career in the restaurant business as an employee at McAlister’s Deli, spearheaded these efforts.
In May 2017, Mr. Goldman, through SD-M, acquired sixty-four (64) Sonic Drive-In restaurants (of the current group of 73 Sonic Drive-In restaurants) from an unaffiliated large franchisee, which acquisition was approved by Sonic Corporate. As part of the 2017 acquisition, the Debtors funded a portion of the purchase price through a sale-leaseback transaction with National Retail Properties and the incurrence of senior secured debt with Pacific Premier Bank.
The Sonic Drive-In restaurant business is seasonal, requiring substantial amounts of working capital during the winter months, and the Debtors’ businesses in 2017 were heavily leveraged. Nonetheless, in December 2017, SD-C acquired seven additional Sonic Drive-In restaurant franchise locations, and two additional Sonic Drive-In restaurant franchise locations in May 2018 in a distressed acquisition. In connection with those transactions, the Debtors refinanced the Pacific Premier Bank credit facilities with the Prepetition Secured Lender, which provided the credit facilities under the Bridge 2017 Loan Agreement in December 2017 and the credit facilities under the Bridge 2018 Loan Agreement in May 2018. The Debtors also used these credit facilities to finance the building out of their MOD Pizza and Fuzzy’s Taco Shop restaurant franchise businesses.
It is my understanding from Mr. Goldman that, in October, 2018, the Debtors received an unexpected $7,000,000 tax bill relating to capital gains from the May 2017 sale-leaseback transaction, further straining the Debtors’ liquidity. During this time, the Debtors continued to develop and invest capital in the MOD Pizza and Fuzzy’s Taco Shop restaurant franchises, ultimately resulting in an unsustainable liquidity situation.
Due to the Debtors’ severe liquidity situation, in or about late December 2018, Mr. Goldman began approaching merchant cash advance providers. Based upon my review of the Debtors’ records (including the MCA Agreements), in December 2018, the Debtors began entering into the MCA Agreements with the MCA Parties. The MCA Agreements indicate that, between December 2018 and December 2019, the Debtors sold no less than $7,988,325 of future accounts receivable to the MCA Parties in exchange for cash payments in an amount not less than $5,880,000, less fees and certain expenses. These records indicate that the MCA Parties purchased the Debtors’ future accounts receivable at significant discounts, charged high fees and had the ability to debit the Debtors’ deposit accounts directly. The depletion of the Debtors’ liquidity attributable to obligations under the MCA Agreements, coupled with the seasonal downturn in the Sonic Drive-In restaurants, left the Debtors’ cash flow position untenable.
During the second half of 2019, the Debtors were in advanced discussions with a potential buyer (the 'Initial Potential Buyer') for their Sonic Drive-In franchise restaurant businesses, and they spent considerable time and money negotiating a definitive asset purchase agreement in connection therewith. The sale of the Debtors’ Sonic Drive-In franchise restaurant businesses (the 'Sonic Disposition') was expected by the Debtors to close in November 2019.
However, delays occurred. Among other issues, the diligence process identified UCC-1 financing statements filed in favor of parties other than the Prepetition Secured Lender, and concerns arose over the ability of SD-C and SD-M to convey their interests in the Sonic Drive-In franchise restaurants free and clear of encumbrances. It became clear that it would be extremely difficult to consummate a Sonic Disposition transaction out of court.
About the Debtors
The Debtors own and operate a large group of franchise restaurants located in the Southeast United States. Specifically, the Debtors are franchisees of (i) seventy-three Sonic Drive-In restaurants in Georgia, North Carolina, Tennessee, Virginia, and Alabama; (ii) fourteen MOD Pizza restaurants in North Carolina (Charlotte, Wake-Forest, Raleigh, and Wilmington); and (iii) three Fuzzy’s Taco Shop restaurants in North Carolina (Charlotte). Collectively, the Debtors employ approximately 1,900 individuals.
Corporate Structure Chart
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