The chapter 11 filings this month of Sbarro and Quiznos share many similarities. Both companies are looking to survive in a difficult sector of a tough industry. Both were forced to seek bankruptcy despite recent successful efforts to reduce debt – an out-of-court restructuring for Quiznos and a 2011 chapter 11 case for Sbarro. In addition, both cases also continued a strong trend of corporate bankruptcies that look to minimize the duration of the case.
Each proceeding is a true “prepackaged” case – a phrase that is often used to describe any number of negotiated arrangements between a debtor and its major creditors, but that is in fact a term of art that properly refers to cases where the requisite votes for approval of the plan of reorganization are solicited and obtained prior to the filing of the bankruptcy petition. The approach works well for effecting balance sheet restructurings, such as where the debtor and its lenders agree to swap out existing debt in exchange for equity in the reorganized enterprise.
Because the entire purpose of a “prepackaged” plan is to allow the debtor to spend as little time in bankruptcy as possible, the debtor and the supporting lenders usually attempt to avoid delays and objections. Such plans therefore will often provide for payment in full to general unsecured creditors. By treating such creditors as “unimpaired” under the plan, their acceptance of the plan can be assumed, the time and expense of soliciting their votes can be forgone, and objections to the plan are minimized.
Sbarro and Quiznos, however, are both deviating from this approach. The plans in both cases are “cramdown” plans. Quiznos’s plan provides a minimal recovery, and Sbarro’s provides nothing, for general unsecured creditors. The time and expense of solicitation can still be forgone, because the assumption here is that such creditors are rejecting the plan. Sbarro and Quiznos intend to ask the bankruptcy judges in their respective cases to approve their plans notwithstanding the presumed rejections (i.e., “cram down” the plan). Both companies will contend that recent severe declines in revenues have reduced the value of their respective enterprises by so much that senior creditors are receiving far less than what they are owed, and no value can flow down to general unsecured creditors.
Unsecured creditors in both cases, unsurprisingly, can be expected to object vehemently. Opponents of the Sbarro and Quiznos plans will use all arguments at their disposal to derail confirmation of the plans. The valuation assumptions will be challenged, as will Sbarro’s and Quiznos’s assertions that they have satisfied the numerous requirements for plan confirmation under Section 1129 of the Bankruptcy Code.
Plan confirmation can be difficult and time-consuming even where consensus exists among creditor constituencies. Therefore, in recent years most chapter 11 cases of so-called “melting ice cube” companies such as Sbarro and Quiznos have involved quick sales under Section 363 of the Bankruptcy Code in order to preserve a debtor’s going concern value. For the lenders who wind up taking control of these business enterprises, however, there can be numerous advantages obtained from confirming a plan of reorganization (for example, valuable tax attributes can often be preserved). In seeking quick confirmation of a non-consensual plan, lenders are effectively making a bet that Sbarro and Quiznos are at this point in such poor shape that there will be no way for unsecured creditors to argue successfully for a share of enterprise value, and that there will be no other valid arguments against plan confirmation that can be asserted.