Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—Bankr. W.D. N.Y.: Secured creditors failed to perfect liens on debtor franchisee’s locations leases, (Sep 8, 2016)

By Linda O’Brien, J.D., LL.M.

Two secured creditors of a debtor bagel bakery franchisee did not have pre-petition liens on the leases for the franchisee’s bakery locations. In granting the franchisor’s motion for a determination of the status of the leases, the federal bankruptcy court in Rochester, New York determined that the lenders failed to perfect their security interests in those leases. The court also ruled that the franchisor was not entitled to assignment of the franchisee’s leases and personal property (In re Flour City Bagels, LLC, September 2, 2016, Warren, P.).

Flour City Bagels, LLC operates 32 Bruegger’s Bagel Bakeries as a franchisee across western and central New York. Flour City is the largest Bruegger’s Bagel Bakeries franchisee in the United States. After defaulting on payments to secured lenders, Flour City filed for bankruptcy protection under Chapter 11 in March 2016 and sought to sell substantially all of its assets to its junior secured lender and sole managing member Canal Mezzanine Partners II, LP for a cash and credit bid of $5 million. Canal was the prevailing bidder at an auction in June 2016.

Franchisor Bruegger’s Franchise Corporation objected to Flour City’s sale motion, contending that its all-cash back-up bid of $4.75 million was the highest and best bid. Before the court were Bruegger’s motions for a determination that Canal and senior secured lender United Capital Business Lending, Inc. did not have any pre-petition liens on Flour City’s bakery and commissary leases and for an order to compel Flour City to assign those leases and all personal property to Bruegger’s under the terms of the franchise agreements.

Status of leases. The court found that lenders Canal and United failed to properly perfect their security interests in Flour City’s leasehold interests under the New York Real Property Law. The argument of Canal and United—that their liens were not on the leases themselves but instead on Flour City’s economic interest in the leases—was rejected as unsupported by any case law. Their security agreements, the court explained, did not adequately describe their collateral as including an interest in Flour City’s leases under the Uniform Commercial Code (UCC). The UCC financing statements used the terms "general intangibles" and "all assets" to describe the collateral and no party searching the UCC filings with the New York Secretary of State would have been on notice that Canal and United asserted a lien on the "economic value" of Flour City’s leases.

Furthermore, Canal and United failed to file any leasehold mortgages with the county clerk in order to perfect a lien on Flour City’s "conveyance" of an interest in the leases as required by New York Property Law, the court noted. Thus, Bruegger’s motion for a determination that Canal and United did not have pre-petition liens in Flour City’s leases was granted.

Assignment of leases and personal property. However, Bruegger’s failed to show its entitlement to the remedy of specific performance to compel Flour City to assign its leases and personal property to Bruegger’s under the franchise agreements. According to the court, Bruegger’s offered no evidence to support its contention that it had no adequate remedy at law. The franchise agreements were not contracts for the sale of real property; rather, they merely related to real property.

Bruegger’s argument that it would suffer irreparable harm if Canal operated Flour City’s bakery locations as bagel shops under a different name was rejected. The court noted that Bruegger’s did not demonstrate anything other than a contract claim with respect to the leases and personal property under the franchise agreements. Bruegger’s did not hold a security interest or assignment of lease for any of Flour City’s bakery locations and failed to offer any evidence that a monetary award would not provide adequate relief, the court concluded.

The case is No. 16-20213-PRW.

Attorneys: Stephen A. Donato (Bond, Schoeneck & King, PLLC) and Harry W. Greenfield (Buckley King LPA) for Flour City Bagels, LLC.

Companies: Flour City Bagels, LLC

Cases: FranchisingDistribution NewYorkNews