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Risky Business – Tips on how to Buy or Sell your Restaurant Business

Buying or selling a business, like any major financial transaction, is complicated and requires competent counsel. Careless mistakes can have very serious financial consequences for both parties. Take, for example, the recent sale, subsequent bankruptcy and pending lawsuit between the former and current owners of the storied Capitol Hill restaurant, Hawk n’ Dove.

Earlier this month, The Washington Business Journal reported on a law suit filed by William Sport, one of the former owners of a group that owned nine District of Columbia restaurants including The Chesapeake Room, Park Tavern, Boxcar Tavern, Hawk n’ Dove, Molly Malone’s, Pacifico, Senart’s Oyster and Chop House, and Willie’s Que and Brew. See the WBJ article here.

Sports and his partners agreed to sell the nine restaurants to Barracks Row Entertainment Group LLC in December 2012 for $19.3 million. According to his complaint, which was filed in federal district court in October of 2013, Sport is alleging that the Defendants falsely represented the ownership of the company making the purchase and fraudulently inducing Sports into a sales contract where he accepted a $4.63 million promissory note as partial payment. Sports also agreed to personally guarantee $5 million in bank debt carried by the restaurants, as well as to continue to personally guaranty the nine commercial restaurant leases. The named Defendants are Richard Cervera, Michael Hoi-Mingh Cheung, William J. Nimmo, and Halpern, Denny & Co., a private equity and venture capital firm. See the filed complaint here – Case 114-cv-01783-JEB.

As with most contentious litigation, it will be some time before this case is resolved. It nonetheless serves to highlight important issues that both sellers and buyers should keep in mind when entering into a sales contract. Below we’ve provided a general overview of the due diligence restaurateurs and entrepreneurs should undertake in any sales transaction. The list is by no means exhaustive and we highly recommend that each party consult with an experience business attorney when entering into any complex legal agreement.

Business for Sale – A Seller’s Prospective

1. Type of Sale – Asset sale or Stock Sale?

An owner can sell the company’s assets outright, or can sell stock in the corporation or membership interests/units if it is a limited liability company. Buyers will always want to structure the deal as an asset sale to protect itself against prior claims and liabilities of the business, as well as receiving a new tax basis in the assets, and higher depreciation and amortization deductions in the future. For the Seller, however, there are advantages to doing a stock sale. If the Seller’s company is a corporation, a stock sale usually results in a lower overall total tax bill than an asset sale. If necessary or the tax bill justifies it, the Seller may wish to consider adjusting the purchase price in order to persuade the buyer to accept a stock transaction rather than an asset sale.

2. Valuation – How to value equipment, inventory, and good will of your business

Whenever a sale of a business produces a capital or ordinary gain, the IRS will expect to receive its share and business owners need to take the potential tax bill into account when entering into a sales contract. In addition to the structure of the deal (asset v. stock sale), another factor the IRS will consider when evaluating the potential tax assessed for the sale of the business is the specific values assigned in the sale of the company’s assets. The gain or loss on the sale of different categories of business assets are taxed differently. Under the Internal Revenue Code, sellers and buyers must assign a specific value to each asset or groups of similar assets, and report a gain or a loss from the sale of each asset to the IRS. The sale of capital assets results in a capital gain or loss; the sale of real property or depreciable property used in the business and held longer than one year results in a gain or loss from a Section 1231 transaction; and the sale of inventory results in ordinary income or loss. It is important that a Seller value its assets accordingly to avoid higher tax classifications.

3. Tax Implications – Understanding capital gains tax and other tax consequences

The tax consequences of buying or selling a business can vary significantly depending on a number of factors, including the issues discussed above. Business owners should meet with legal and tax professionals beforehand to discuss tax strategies for making the company attractive to buyers, while minimizing their own tax liabilities.

4. Solvency of Buyer – Do you know who your buyer is?

In the sales transaction for Hawk n’ Dove, the buyer of the restaurants could not afford the full asking price of $19.3 million dollars so the seller accepted a $4.63 million promissory note as partial payment for the balance. Unfortunately, within a year, the Buyer filed for Chapter 11 bankruptcy which halted payments to the Seller on the note. The Seller also alleges that he did not know the true owners of the corporate entity that bought his restaurants. The circumstances of this case are a cautionary tale and reminder to any Seller that he or she must do sufficient due diligence when selecting a suitable buyer. At a minimum, the Seller should review the Buyer’s financial statements, Buyer’s credit history, the Buyer’s resume and business plan, and if possible, seek references or third party input with individuals or businesses who have dealt with the Buyer in the past.

5. Financing Issues – Seller/Owner Financing has advantages and risks

It is not uncommon for a portion of the purchase price to be paid over time, in the form of a promissory note. In essence, the Seller is financing part of the sales price for the Buyer. There are certain tax advantages to deferring payment but there are also substantial risks that the Buyer may default, file bankruptcy or otherwise fail to meet its obligations under the note. Therefore, it is important for the Seller to negotiate personal guarantees from the Buyers, file security interests on the business assets to be sold, or draft strong default provisions to prepare for worst-case scenarios.

These are just a few issues the Seller must consider when selling its business, and we highly recommend that each party consult with experienced legal and tax professionals when entering into a sales agreement. In a later post, we will discuss issues Buyers must consider when purchasing a business.

Doyle, Barlow & Mazard has experiences representing buyers and sellers in the sale of a business. For more information, contact

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Rosemarie Salguero, Esq.
rsalguero@dbmlawgroup.com
(202) 589-1836

ABRA to Hold Hearing on Procedural and Administrative Changes to Title 23

From ABRA:

The Alcoholic Beverage Control Board (Board) will conduct a public hearing at 9 a.m. on Thursday, November 13 to receive public comment on proposed rules that would make procedural and administrative changes to Title 23 of the D.C. Municipal Regulations:

Read more

Restaurant Franchisors May Be Liable for Violations of the Fair Labor Standard Act Committed by their Franchisees

The restaurant and hospitality industry has long been a target for labor and wage law suits by employees seeking back wages under the Fair Labor Standards Act (“FLSA”).  The newspaper headlines are full of lawsuits against renowned celebrity chefs, such as Tom Colicchio, Mario Batali, and Daniel Boulud, just to name a few.   These disputes can be costly as Mario Batali’s $5.25 million settlement demonstrates.   Many more FLSA lawsuits may plague the industry if minimum wage increases are approved by local county and state legislatures (see our posts about local wage increases here and here).

In Naik v. 7-Eleven[1],  a New Jersey District Court Judge’s recent decision should place franchisors on alert as it pertains to wage law suits.   On August 5, 2014, United District Court Judge Renee Bumb of the District of New Jersey ruled against the franchisor, 7-Eleven, Inc., by refusing to dismiss a wage and hour case where 7-Eleven franchisees claimed to be employees of their franchisor.   The Plaintiffs signed franchise agreements with 7-Eleven, Inc., however, Plaintiffs contend that despite being designated as “independent contractors” in the franchise agreement, “the economic reality of the relationship is that the Plaintiffs are employees of Defendant, and, therefore, they are entitled to the protections under the Fair Labor Standards Act.”[2]

Courts apply the “economic reality” test to evaluate the employer/employee relationship under the FLSA.  This four-part test generally requires consideration of (1) the power to hire and fire, (2) supervision and control of work schedules and conditions of employment, (3) determining the rate and method of payment, and (4) maintaining employment records.    However, the Third Circuit has taken a very expansive view of who is an employee under the FLSA, which Judge Bumb considered in her decision. These include: (1) the degree of the alleged employer’s right to control the manner in which the work is to be performed; (2) the alleged employee’s opportunity for profit or loss depending upon his managerial skill; (3) the alleged employee’s investment in equipment or materials required for his task, or his employment of helpers; (4) whether the service rendered requires a special skill; (5) the degree of permanence of the working relationship; and (6) whether the service rendered is an integral part of the alleged employer’s business.[3]

Although, Judge Bumb’s decision allows the 7-Eleven franchisees suit to proceed against the national franchisor, the Plaintiffs still have the burden to prove their allegations that they were employees and that the franchisor violated federal and state labor laws.   To contrast, the Court of Appeals for the Fifth Circuit recently reversed a jury verdict and award for damages for violations of the FLSA entered against the franchisor.   In Orozco v. Plackis[4], the Fifth Circuit examined the facts of the case and determined that although the franchisor provided training to the employees and made employment suggestions on ways to increase profitability, these actions did not demonstrate that the franchisor had control over employment decision sufficient to render them liable as a joint employer.  Most importantly, the Fifth Circuit held that language in the franchise agreement regarding the franchisee having to follow the franchisor’s “policies and procedures” regarding the “selection, supervision, or training of personnel” did not suggest that the franchisor had control over or supervised the franchisee’s employees.

Obviously, this test is very fact-intensive and unique for every case, but franchisors need to keep these factors in mind when negotiating their franchise agreements.  The franchisor-franchisee relationship requires a delicate balance of powers primarily due to the franchisor’s focus on quality control of its brand and intellectual property, but the franchisor needs to ensure that their brand oversight does not lead to true operational control over the franchisee’s employees or into the day-to-day employment practices of the franchisees.

Doyle, Barlow & Mazard has experience defending hospitality clients in wage and hour suits, and other employment-related matters.  For more information contact

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Rosemarie Salguero, Esq.
rsalguero@dbmlawgroup.com
(202) 589-1836

 

 

 


[1] Naik v. 7-Eleven, Inc., Case No. 1:13-cv-04578-RMB-JS, (D.N.J. 2013).

[2] Naik, Docket No. 117 at p.2.

[3] Naik, Docket No. 117 at p.7.

[4] Orozco v. Plackis, 2014 WL 3037943, No. 13-50632 (5th Cir. July 3, 2014).

ABRA to Host Orientation Training on Oct. 23

From ABRA:

ABC licensees and members of the public are invited to attend ABRA orientation training from 2-4 p.m. on Thursday October 23 to learn about:

  • District ABC laws and regulations (including recent changes to the law)
  • Tips for working effectively with the community
  • Settlement Agreements
  • Expectations of ABC licensees
  • Best practices
  • Noise abatement and sound management

Contact ABRA Community Resource Advisor Sarah Fashbaugh by Friday, October 17 to register:

Attendance for this class is strongly recommended for new ABC license holders. Training is free of charge. Requests for interpreters may be made; however, they must be submitted by the registration deadline. Training will be held at:

2000 14th Street, NW
Suite 400 South, 4th Floor
Washington, DC 20009

 

Potential Changes to the Joint Employer Liability Standard May Affect Franchise Business Model

On July 29, 2014, the National Labor Relations Board (“NLRB” or “Board”) authorized 43 complaints against McDonald’s franchisees for alleged violations of the National Labor Relations Act.[1]  The Board also named the franchisor, McDonald’s USA, LLC, as a joint employer respondent in the cases, making the national franchisor potentially liable for the acts of its franchisees.  Two months prior, on May 12, 2014, the NLRB invited parties to file amicus briefs addressing the “Board’s joint employer standard, as raised in its pending case, Browning-Ferris Industries (Case 32-RC-109684).”[2]

The NLRB announcements are significant because they foreshadow a potential change to the NLRB’s current legal standard for the franchise industry, namely, that as long as the franchisee is an independent contractor who maintains full control over the internal daily management of the franchised business, the franchisor is not a joint employer and not liable for any unlawful employment practices committed by its franchisee.

Franchises are common in the hospitality and restaurant industries, and there exists a delicate balance of powers between the franchisor and franchisee.  The franchisor seeks to protect its brand and its intellectual property by establishing standards so that each customer receives the same level of service and products at each franchise location. Franchisees benefit from the goodwill associated with the brand, and by receiving training, software and support from the franchisor.  Under most franchise agreements, the franchisee remains an independent contractor with full control over the day-to-day management of its business including its employment practices.

Since 1984, the NLRB legal analysis for determining joint employer liability focused on a showing of “significant control” by the alleged joint employer over matters relating to the employment relationship such as hiring, firing, discipline, supervision, and direction.  See Laerco Transportation, 269 NLRB 324 (1984).  This analysis resulted in few franchisors being deemed joint employers.  In its June 26, 2014 amicus brief for the Brown-Ferris Industries case currently pending before the Board, the General Counsel of the NLRB urged the Board to “return to the Board’s traditional approach prior to Laerco Transportation and TLI, Inc.,” and the adoption of a standard “that takes account of the totality of the circumstances, including how the putative joint employers structured their commercial dealings with each other.”[3]  This standard, according to the brief, “would make no distinction between direct, indirect, and potential control over working conditions,” and would find unexercised “potential control . . . sufficient to find joint-employer status.”  The Board’s July announcement regarding the McDonald’s complaints may be a hint that it intends to adopt the broad joint employer test advocated by its General Counsel.

If this new standard is adopted, franchisors will have to take greater precautions to ensure that the oversight over their brand, dictated in the Franchise Agreement, does not expose them to increased liability for the adverse employment actions of their franchisees.  To that end, franchisees need to carefully avoid any requirement that implicates any direct employment practice, such as recruitment, hiring, firing, payroll issues, reviewing employment records or tracking employee wages and performance.

The Board has yet to rule in the Browning-Ferris Industries case but franchisors need to carefully examine their franchise agreements and guard against any hint of franchise control that would expose it to greater liability via the NLRB’s potential heighten standards for joint employment.

Doyle, Barlow & Mazard has experience drafting and reviewing complex contracts, including franchise agreements, on behalf of restaurant clients.  For more information, contact

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Rosemarie Salguero, Esq.
rsalguero@dbmlawgroup.com
(202) 589-1836


[1] www.nlrb.gov/news-outreach/news-story/nlrb-office-general-counsel-authorizes-complaints-against-mcdonalds; See also http://www.nlrb.gov/case/32-RC-109684

[2] www.nlrb.gov/news-outreach/news-story/nlrb-invites-briefs-joint-employment-standard

[3] www.laborrelationsupdate.com/files/2014/07/GCs-Amicus-Brief-Browning-Ferris.pdf

ABRA to Host Books and Records Training Seminar

On September 25, 2014, Alcoholic Beverage Regulation Administration (“ABRA”) will host a Books and Records Training seminar. ABC licensees of hotels and restaurants are invited to attend.

Training will cover:

  • Food sales requirements
  • Food sales reporting
  • Quarterly statement filings
  • Books and records tracking

Read more

New D.C. Guidelines Clears Operation of Certain Online Alcohol Services

On August 14, 2014, the Alcoholic Beverage Control Board (“Board”) issued new guidelines that will allow unlicensed websites and smartphone applications to provide alcohol services in the District.

The Alcoholic Beverage Regulation Administration (“ABRA”) recently reviewed several technology businesses that partner with liquor-licensed retailers to provide alcohol order and delivery services, among which are Drizly and Klink, internet-based alcohol delivery services. The Board did not find their business models in violation of D.C. law.

The Board advises technology companies facilitating the sale of alcohol through websites and apps to limit their operations to:

  • Connecting consumers over the Internet to District retailers such as liquor and grocery stores; and/or
  • Promoting a retailer’s alcoholic products.

Technology companies are restricted from:

  • Soliciting, selling and shipping orders for alcoholic beverages;
  • Storing alcoholic beverages for sale to consumers; and
  • Collecting any money, fees or transacting any credit or debit cards for the sale of alcoholic beverages.

Any credit or debit card information provided to a website or app would need to be transferred to a liquor-licensed retailer in order to complete the transaction. The licensee would also need to retain the discretion to process or deny any order.

The Alcohol delivery service, Ultra, which runs on a similar model to Drizly and Klink, was subject to a cease-and-desist order from ABRA in late June of this year. However, unlike Drizly and Klink, Ultra acts as the collector of customers’ payments before forwarding the amount, minus its commission, to its partner D.C. liquor stores.

A technology company that violates D.C. law could be subject to criminal and civil penalties as well as an order to cease operations in the District.  A licensed retailer that violates the law could face fines and possible suspension or revocation of its license.

ABRA Hosts ID Compliance Training

The Alcoholic Beverage Regulation Administration (“ABRA”) will be hosting a special ID Compliance training for ABC licensees and their staff to review:

  • Techniques for properly verifying IDs
  • Tips for spotting fake IDs
  • Information on ABRA compliance checks

Read more

Labor Day Weekend the End of Extended Holiday Hours Program

The extended holiday hours program allows on-premise establishments to stay open twenty-four hours a day, and to serve alcohol before 4 a.m. on certain holidays and holiday weekends. The Labor Day Weekend will be the last time this summer that establishments registered for extended holiday hours can stay open later for an entire weekend.

During Labor Day Weekend, alcohol service must end at 4 a.m. on the mornings of Saturday, Aug. 30; Sunday, Aug. 31; and Monday, Sept. 1.

On-premise establishments that want to participate in the extended holiday hours program have until Friday, August 1 to do so.  Once the licensee is signed up for the program, the establishment can participate in all eligible holidays listed on the calendar during the same year. The calendar is available here: http://abra.dc.gov/node/695172

Application is available here: http://abra.dc.gov/node/671792.

While the summer holidays end with the Labor Day Weekend, Columbus Day Weekend on Monday, Oct. 13, mark the beginning of the fall extended holiday hours.

New Permit Allows On-Premise Consumption at D.C. Breweries

On July 14, 2014, the Alcoholic Beverage Regulation Administration (“ABRA”) made available a new permit that will allow on-premise consumption of alcohol at breweries located in the District of Columbia. The permit is a provision of the Fiscal Year 2015 Budget Support Emergency Act of 2014.

A brewery located in the District of Columbia can apply for an on-site sales and consumption permit with ABRA under the Manufacturer Tasing Permit Emergency Amendment Act of 2014. With the permit, customers can purchase and consume beer that is brewed at the brewery on the brewery’s premise from 1 p.m. to 9 p.m., seven days a week.

The annual fee for the permit is $1,000.  Interested parties can apply for the permit here:
http://abra.dc.gov/node/864522

The permit is not mandatory for brewers.  In addition, if a brewery wishes to offer free samples of beer to customers on its premise, it must apply for a separate tasting permit to do so.