In re Flour City Bagels, LLC, Case No. 16-20213-PRW

• Decision Date: 02 September 2016
• Docket Number: Case No. 16-20213-PRW
• Citation: 557 B.R. 53
• Parties: In re: Flour City Bagels, LLC, Debtor.
• Court: U.S. Bankruptcy Court — Western District of New York

557 B.R. 53

In re: Flour City Bagels, LLC, Debtor.

Case No. 16-20213-PRW

United States Bankruptcy Court, W.D. New York.

Signed September 2, 2016

Stephen A. Donato, Camille W. Hill, Bond, Schoeneck & King, PLLC, Syracuse, NY, Harry W. Greenfield, Heather E. Heberlein, Jeffrey C. Toole, Buckley King LPA, Cleveland, OH, for Debtor.

DECISION AND ORDER GRANTING BRUEGGER'S MOTION FOR AN ORDER DETERMINING THAT LENDERS DO NOT HAVE PRE-PETITION LIENS ON LEASES; DENYING BRUEGGER'S MOTION TO COMPEL ASSIGNMENT OF LEASES AND PERSONAL PROPERTY; DENYING DEBTOR'S MOTION TO APPROVE SALE OF SUBSTANTIALLY ALL OF DEBTOR'S ASSETS FREE AND CLEAR OF ALL LIENS; AND DENYING AS MOOT DEBTOR'S MOTION TO ASSUME AND ASSIGN EXECUTORY CONTRACTS AND UNEXPIRED LEASES

PAUL R. WARREN, United States Bankruptcy Judge

The perfectly round symmetry of a bagel bears little resemblance to the sharp angles that divide the parties in this Chapter 11 case. The Debtor, Flour City Bagels, LLC (“Flour City”), is a 33-year-old company that operates 32 Bruegger's Bagel Bakeries—as a franchisee—across western and central New York, employing over 400 people. (Coyne Decl., Debtor Ex. 21 ¶¶ 3-4). Flour City is the largest Bruegger's Bagel franchisee in the United States. But something went wrong with Flour City's long-running business. After a series of payment defaults by Flour City on its obligations to its secured lenders, beginning in 2014 and continuing into 2015, on August 4, 2015, Flour City's junior secured lender—Canal Mezzanine Partners II, LP (“Canal”)—exercised its contractual right to assume control of Flour City's sole managing member, HOT, LLC (“HOT”). (Id. ¶ 11). Since that time, Canal has operated Flour City's business. Canal has attempted to resurrect Flour City—to protect its investment—by terminating its former officers, by hiring numerous professionals to examine its books and to improve its operations, by negotiating with and paying down arrearages to its landlords, vendors, secured and priority creditors, and the franchisor, and ultimately by filing for bankruptcy to stave-off hungry creditors. (Id. ¶¶ 12-23).

Flour City filed for protection under Chapter 11 on March 2, 2016, listing secured debt in excess of $11 million and unsecured debt of nearly $3 million. (ECF Nos. 1, 322). Assets were estimated to have a value of $2.9 million. (ECF No. 322). According to Flour City, “[t]he purpose of the Debtor's chapter 11 case was to market and sell substantially all of the Debtor's assets as a going concern to a qualified third-party purchaser under section 363 of the Bankruptcy Code.” (ECF No. 404 ¶ 10).

Flour City now seeks Court approval to sell substantially all of its assets, free and clear of all liens or interests, to Canal—the sole managing member of Flour City and the prevailing bidder at an auction held on June 28, 2016, for $5 million (consisting of $1.3 million in cash and $3.7 million in the form of a credit bid) (“Sale Motion”). (ECF No. 404 ¶¶ 24-27). Bruegger's Franchise Corporation, Bruegger's Enterprises, Inc., LDA Management Company, Inc., and Le Duff America, Inc. (collectively, “Bruegger's”)—the back-up bidder, by virtue of its all-cash bid of $4.75 million—vociferously objects to the Sale Motion (ECF No. 431). Bruegger's contends that its all-cash bid was the highest and best bid. (Id. at 16-17). Bruegger's further asserts that the auction was not conducted in good faith because of the conflict created by the incestuous relationship between Canal and Flour City—resulting in Canal acting as both the seller and the buyer at the auction. (Id. at 22-23). Bruegger's also made two separate motions, which must necessarily be disposed of before deciding Flour City's Sale Motion. (ECF Nos. 403, 425). First, Bruegger's seeks a determination that neither Canal nor the senior secured lender, United Capital Business Lending, Inc. (“United”), have any pre-petition liens on Flour City's bakery and commissary leases (“Motion to Determine Status of Leases”). (ECF No. 403). Second, Bruegger's seeks an Order compelling Flour City to assign all of those leases and all personal property to Bruegger's under the terms of its Franchise Agreements with Flour City (“Motion to Compel Assignment”). (ECF No. 425).

Because Canal and United failed to perfect their security interest in Flour City's leases, Bruegger's Motion to Determine Status of Leases is GRANTED . However, because Bruegger's likewise failed to perfect its interest in the leases or personal property—and because Bruegger's has demonstrated no right to specific performance—Bruegger's Motion to Compel Assignment is DENIED .

Turning to Flour City's Sale Motion to sell substantially all of its assets under 11 U.S.C. § 363(b), the Court finds that—based on the evidence offered at trial on the Sale Motion and after extensive briefing by the parties—Flour City has failed to carry its burden to prove by a preponderance of evidence that it exercised sound business judgment in selecting the bid of Canal as the highest and best bid. See In re Lionel Corp. , 722 F.2d 1063, 1071 (2d Cir.1983). Flour City has also failed to demonstrate a basis to sell its assets free and clear of liens under either § 363(f)(2) or (3) of the Code. Flour City's Sale Motion is DENIED . As a result, Flour City's request that the Court approve the Asset Purchase Agreement (“APA”) between Flour City and Canal is rendered MOOT . And Flour City's request to assume and assign certain executory contracts and unexpired leases to Canal is also rendered MOOT .

I. JURISDICTION

The Court has jurisdiction of this matter under 28 U.S.C. §§ 157(a), 157(b)(1) and 1334. This is a core proceeding under 28 U.S.C. § 157(b)(2)(K) and (N). This decision constitutes the Court's findings of fact and conclusions of law under Rule 7052 FRBP.

II. FINDINGS OF FACT

On July 21 and 22, 2016, the Court held a trial on Flour City's Sale Motion. At trial, Flour City called three witnesses in support of the Sale Motion: Michael Jacoby (“Jacoby”), Flour City's investment banker from Phoenix Capital Resources (“PCR”); Richard Szekelyi (“Szekelyi”), Flour City's chief restructuring officer from Phoenix Management Services, LLC (“PMS”); and Kevin Coyne (“Coyne”), the principal of Canal responsible for Flour City's operations. Bruegger's offered the testimony of one witness: Robert Parette (“Parette”), Bruegger's former Chief Financial Officer. Canal called one witness, Michael Koeppel (“Koeppel”), to offer an expert opinion on the value of Flour City's leases. The following are findings of fact—made under Rule 7052 FRBP —based on the testimony of the witnesses and exhibits received in evidence at trial.

A. Background—and so it begins...

Flour City operates 32 Bruegger's Bagel Bakeries, concentrated in Rochester, Albany, and Syracuse. (Coyne Decl., Debtor Ex. 21 ¶ 3). Its flagship bakery opened in Troy, New York in 1983. (Id. ). Locations expanded to Rochester, beginning in 1990, and then to Syracuse and Albany, beginning in 1993. (Id. ). Also in 1993, Flour City opened a commissary in Rochester, which produces the bagel “pucks” cooked and sold at its 32 bakery locations. (Id. ¶ 4; Sale Hr'g Tr. at 110). Flour City now employs about 425 people. (Coyne Decl., Debtor Ex. 21 ¶ 4).

Until 2014, Flour City was managed and controlled by three principals: F. Kenneth Greene (“Greene”), Richard DeCarr (“DeCarr”), and Michael Borrelli (“Borrelli”). (Id. ¶ 11). Greene, DeCarr, and Borrelli collectively owned all of the membership interests of HOT—the sole managing member and parent company of Flour City. (Id. ¶¶ 6, 8; Sale Hr'g Tr. at 330-31). After DeCarr's departure from the company in 2014, Greene and Borrelli continued to manage and control Flour City until their forced termination by Canal in August 2015. (Coyne Decl., Debtor Ex. 21 ¶ 11). To date, Greene, DeCarr, and Borrelli remain owners of the membership interests of HOT. (Id. ; Sale Hr'g Tr. at 331:8-14).¹

B. Franchise Agreements with Bruegger's

Since its founding, Flour City has operated its bakeries as a Bruegger's Bagel Bakery franchisee. Flour City is now the largest Bruegger's franchisee in the United States—owning 32 of the approximately 100 franchised Bruegger's Bakery locations as of the date of the petition. (See Sale Hr'g Tr. at 180:13-14, 392:1-5; Debtor Ex. 2 at 7).² Flour City and Bruegger's entered into Franchise Agreements in connection with each of the 32 store locations. (See Bruegger's Exs. 7a-7jj). Many—if not all—of those Franchise Agreements have now expired by their terms, despite the negotiation of several extensions. (See Coyne Decl., Debtor Ex. 21 ¶¶ 19-23; Bruegger's Exs. 7a-7jj).

Specifically, in February 2001, Flour City entered into 31 Franchise Agreements with Bruegger's, which expired on December 1, 2014. (ECF No. 403 ¶ 2). Flour City operated the 31 bakeries on a month-to-month basis through July 31, 2015. (Id. ). One of those bakery locations closed on July 15, 2015. (Id. ). The remaining 30 Franchise Agreements expired on July 31, 2015, when Bruegger's withdrew its consent to continued month-to-month operation. (Id. ). In 2005 and 2009, Flour City and Bruegger's entered into two more Franchise Agreements, covering the Pittsford Library and Monroe-Clover locations. (Id . ¶ 3). Those agreements had expiration dates of September 9, 2015 and December 28, 2019. (Id. ). By two extension agreements, Bruegger's extended the term of all 32 Franchise Agreements to run through October 31, 2015. (Id. ¶¶ 5-7).

On October 30, 2015, and again on January 22, 2016, Bruegger's sent notice to Flour City that it was exercising its rights under the Franchise Agreements, following their expiration. (ECF No. 425 ¶¶ 13, 16 & Exs. F & H; Bruegger's Exs. 7kk, 7ll). Bruegger's demanded that Flour City assign to Bruegger's its interest in all leases and sub-leases, with respect to 24 of Flour City's bakery locations. (ECF No. 425 ¶¶ 13, 16 & Exs. F & H; Bruegger's Exs. 7kk, 7ll). Bruegger's also exercised its right...