Quiznos 2014 Chapter 11 Bankruptcy Filing
Quiznos (QCE Finance LLC, et al) filed for Chapter 11 Bankruptcy on March 14, 2014 in the United States Bankruptcy Court for the District of Delaware under Case No. 14-10543-PJW-11.
Stuart K. Mathis, is the Chief Executive Officer and President of QCE Finance LLC (“Holdco” and, together with its subsidiary debtors and debtors in possession, the “Debtors”). He have been employed as Holdco’s Chief Executive Officer and President since July 2012.
The Quiznos entities in Bankruptcy
The Debtors in the cases, along with the last four digits of each Debtor’s federal tax identification number, are: QCE Finance LLC (7897); American Food Distributors LLC (8099); National Marketing Fund Trust (4951); QAFT, Inc. (6947); QCE LLC (2969); QFA Royalties LLC (2402); QIP Holder LLC (2353); Quiz-CAN LLC (7714); Quizno’s Canada Holding LLC (3220); Quiznos Global LLC (2772); The Quizno’s Master LLC (3148); The Quizno’s Operating Company LLC (8945); The Regional Advertising Program Trust (2035); Restaurant Realty LLC (8293); and TQSC II LLC (8683).
Quiznos Corporate Structure
Primary Purpose of the Chapter 11 Bankruptcy Filing | Prepackaged Plan
Mr. Mathis discusses the 2014 Bankruptcy Filing of Quiznos:
“Simultaneously with the filing of [the bankruptcy case], the Debtors have filed their chapter 11 plan of reorganization (the “Plan”), and its accompanying disclosure statement (the “Disclosure Statement”). The Plan represents the culmination of months of negotiations with significant holders of the Debtors’ prepetition secured indebtedness, with whom the Debtors have entered into a Restructuring Support Agreement (as defined and discussed further below). Pursuant to the Plan, among other things, (a) the Debtors will reduce their total secured debt obligations by over $400 million, (b) the Reorganized Debtors’ will have access to $25 million of incremental funding that will enable them to support their go-forward business needs, (c) the Debtors will satisfy the claims of lenders (the “First Lien Lenders”) under the First Lien Credit Agreement (as defined below) with a combination of consideration consisting of a new $200 million credit facility and equity in reorganized Holdco (“Reorganized Holdco”), (d) the Debtors will satisfy the claims of Vectra Bank Colorado, National Association (“Vectra”), as the lender under the Marketing Fund Trusts Credit Agreement (as defined below) through an amended agreement that will ultimately provide for Vectra’s repayment in full over a period of time, and (e) satisfy the claims of the Debtors’ unsecured creditors, at the option of unsecured creditors with allowed claims, through either (i) the proceeds from the litigation against certain former officers, managers and related parties of the Debtors or (ii) equity in Reorganized Holdco.
“On March 11, 2014, prior to the commencement of these cases, the Debtors began the solicitation of votes on their Plan. The only creditors entitled to vote on the Plan are the First Lien Lenders and Vectra. The Debtors have not solicited the votes of any of their unsecured creditors. Such creditors will be deemed to reject the Plan and the Debtors intend to seek confirmation of the Plan pursuant to the “cramdown” provisions of Bankruptcy Code section 1129(b).
“The voting deadline expired shortly prior to the filing of these chapter 11 cases. As of the time of filing, I am informed that Vectra, the sole holder of claims on account of the Marketing Fund Trusts Credit Agreement (as defined below), and 100% of the First Lien Lenders that voted, have voted to accept the Plan. Moreover, the First Lien Lenders that have voted to accept the Plan represent approximately 88% of the principal amount outstanding under the First Lien Credit Agreement (as defined below) and approximately 87% of the total number of all First Lien Lenders entitled to vote on the Plan, excluding insiders.
“In addition, to minimize any adverse effects that filing for chapter 11 reorganization relief may have on their business, the Debtors have requested various types of “first day” relief (collectively, the “First Day Motions”). The First Day Motions seek relief intended to allow the Debtors to perform and meet those obligations necessary to fulfill their duties as debtors in possession. I am familiar with the contents of each First Day Motion (including the exhibits thereto), and I believe that the relief sought by each First Day Motion: (a) is necessary to enable the Debtors to operate in chapter 11 with minimum disruption or loss of productivity or value; (b) constitutes a critical element in achieving a successful restructuring of the Debtors’ operations and balance sheet; (c) best serves the Debtors’ estates and creditors’ interests; and (d) is, in those instances where the relief seeks immediate payment of prepetition amounts, necessary to avoid immediate and irreparable harm. The facts set forth in each First Day Motion are incorporated herein by reference.
“I submit this Declaration to provide an overview of the Debtors, their business and these chapter 11 cases, as well as to support the Debtors’ chapter 11 petitions and the First Day Motions. Except as otherwise indicated herein, all facts set forth in this Declaration are (a) based upon by personal knowledge of the Debtors’ operations and finances, (b) learned from my review of relevant documents and information supplied to me by other members of the Debtors’ management and the Debtors’ advisors, or (c) my opinion based on my experience, knowledge and information concerning the Debtors’ industry, operations and financial condition. I am authorized to submit this Declaration on behalf of the Debtors, and, if called upon to testify, I could and would testify competently to the fact set forth herein.
“This Declaration is divided into four parts. Section I of this Declaration provides an overview of the Debtors’ history, business and operations. Section II of this Declaration describes the Debtors’ prepetition capital structure. Section III describes the events giving rise to these chapter 11 cases and other information regarding these chapter 11 cases. Section IV summarizes the relief requested in the First Day Motions.
Description of the Debtors’ Corporate History and Business Operations
The Debtors’ Corporate History and the 2012 Restructuring
“The Debtors’ business was established in 1981 with the opening of its first restaurant in Denver, Colorado. In 1991, the Schaden family purchased certain assets of Quiznos America, Inc. and formed what later became known as The Quizno’s Corporation (“TQC”). In 1994, TQC completed an initial public offering and became a NASDAQ listed company. In December 2001, TQC commenced a going private transaction. The Debtors have been privately held since that time.
“On May 5, 2006, certain affiliates of J.P. Morgan Partners, LLC entered into an agreement to purchase 49% the Debtors’ then-existing equity from Richard E. Schaden and a group of other then-existing owners (the “2006 Leveraged Buyout”). In conjunction with this transaction, the Debtors entered into a $650 million first lien credit facility (the “Prior First Lien Credit Facility”), a $225 million second lien credit facility (the “Prior Second Lien Credit Facility” and, together with the Prior First Lien Credit Facility, the “Prior Credit Facilities”), and a $75 million revolving credit facility with a syndicate of lenders.
“In or about 2011, the Debtors engaged in negotiations with certain significant lenders under the Prior Credit Facilities regarding the terms of a restructuring of the Debtors’ then-outstanding indebtedness. These lenders and the Debtors agreed to the terms of a restructuring, which was implemented through an out-of court exchange offer for the Prior Credit Facilities in January 2012 (the “2012 Restructuring”) that resulted in the Debtors’ current capital structure. The principal terms of the 2012 Restructuring were as follows:
the lenders under the Prior First Lien Credit Facility received payment of all accrued and unpaid interest and their pro rata share of a $75 million paydown of the aggregate principal amount outstanding under the Prior First Lien Credit Facility;
the lenders under the Prior First Lien Credit Facility were provided the option to either amend the Prior First Lien Credit Facility (resulting in the current First Lien Facility (as defined below)) or exchange their holdings of the Prior First Lien Facility for indebtedness under the Second Lien Credit Agreement (as defined below), which amendment and exchange collectively resulted in the approximately $618.5 million in principal amount of outstanding secured debt that the Debtors are now restructuring pursuant to the Plan;
the maturity date of the Prior First Lien Credit Facility was extended;
the lenders under the Prior Second Lien Credit Facility received their pro rata share of 40% of the equity interests in Holdco (before dilution pursuant to a management incentive plan); and
certain controlled affiliates, managed accounts or funds of Avenue Capital Management II, L.P. (“Avenue”), in a private placement transaction, acquired the remaining 60% of the equity interests in Holdco (before dilution pursuant to a management incentive plan) in exchange for $150 million; and
the Marketing Fund Trusts Credit Agreement (as defined below) was amended to extend the maturity date thereunder, and the line of credit available thereunder was reduced from $20 million to $12 million.
“As part of the 2012 Restructuring, Avenue and certain controlled affiliates, managed accounts or funds of Fortress Investment Group (“Fortress”), as lenders under the Prior First Lien Credit Facility, collectively agreed to exchange $150 million of their holdings of the Prior First Lien Credit Facility for indebtedness under the Second Lien Credit Agreement. Further, following the 2012 Restructuring, Avenue and Fortress became the primary equity holders of Holdco.
The Debtors’ Corporate Structure
“The corporate structure chart, attached hereto as ExhibitA, provides a general overview of the corporate structure for the company, including both Debtor and non-Debtor entities. Qui
“QCE is the main operating company and nerve center of the Debtors. Among other things, QCE is responsible for all of the Debtors’ general corporate functions. The remaining Debtors are organized roughly along their respective business functions, certain of which are legacy legal entities with no material operations.
The Debtors’ Operations
“The “Quiznos” brand is well-recognized and has a distinct consumer positioning in its core markets. Known for a superior quality product that is hand-crafted with fresh ingredients and sauces that feature a full-flavor profile, the Debtors operate primarily a lunch and dinner concept. The Debtors’ traditional restaurants offer seated dining and sell a full range of submarine and other sandwiches, salads, soups, food products and beverages. In addition, the Debtors franchise non-traditional restaurants, which include, among other locations, restaurants found in airports, convenience stores and gasoline facilities, sports facilities, hospitals and college campuses. Franchise owners own and operate over 99% of the Debtors’ locations, with the company owning the remainder.
“As of March 10, 2014, the Debtors had 2,034 branded restaurants located in every U.S. state, Puerto Rico, Canada4 and in the following 29 additional countries around the world: Aruba, Bahamas, Brazil, Cayman Islands, Costa Rica, Curacao, Dominican Republic, Ecuador, El Salvador, Guatemala, Guyana, Honduras, Iceland, India, Ireland, Jamaica, Kuwait, Mexico, Netherland Antilles, Nicaragua, Panama, Paraguay, Philippines, Qatar, Saudi Arabia, Singapore, South Korea, United Kingdom and Venezuela.
“The Debtors operate through two primary business segments: (a) franchising, including food and supply distribution, and (b) company-owned restaurants. In 2013, the Debtors generated $636.4 million of global system-wide sales resulting in total revenue of $235.9 million.
The Franchise System
“Date, excluding the six company-owned restaurants, all of the restaurants in the United States were owned by franchisees. In 2013, there were 24 new store openings, 521 store closings and 135 stores for which a franchise agreement has been executed, but the store has not yet been opened.
“As a franchisor, the Debtors have an established infrastructure to serve thousands of prospective and current franchise owners. Organized as an integrated franchising company, the Debtors generate cash flow from multiple sources and have a low fixed cost operating platform that, among other things: (a) sells franchises; (b) assists franchise owners in the opening of restaurants; (c) delivers products and promotions to the company-owned and franchised restaurants; (d) assures consistency and quality across the company-owned and franchised restaurants; (e) collects royalties and other payments from franchise owners; and (f) manages the “Quiznos” brand.
“In franchise operations, revenue is principally derived from royalty fees and initial franchise fees. Franchise owners are required to pay the Debtors royalties based on a percentage of restaurant sales, net of discounts. Depending upon which form of franchise agreement the franchisee entered into, and the type of restaurant the franchisee operates, the royalty fee ranges from 4% to 8%, with the typical royalty fee being 7%. Franchisees also pay initial franchise fees which are typically $10,000, but can range from $0 to $10,000, depending on the type of franchise sold. Prior to 2009, the franchise fee paid by a franchisee had been up to $25,000. Other franchise operations revenue is derived from transfer fees, lease review fees and gift card breakage. In food distribution, the Debtors’ revenue is derived from providing food, restaurant supplies and restaurant equipment procurement and logistical services from third party vendors to the Debtors’ franchise owners through third party distribution centers.
“U.S.-based franchisees are also obligated to pay advertising fees to the Marketing Fund Trusts, which fees are used for regional and national advertising. The Marketing Fund Trusts conduct the business of collecting and administering advertising fees from franchise owners in the United States. As of March 10, 2014, most of the Debtors’ U.S. restaurants paid 1% of their “gross sales” (as defined in the franchise agreement) to the National Marketing Fund Trust and 3% of their “gross sales” to the Regional Advertising Program Trust. The Marketing Fund Trusts use these advertising fees to (a) produce and place media advertising, brochures, collateral advertising materials and other advertising or public relations materials; (b) undertake market research; (c) pay the commissions, fees and expenses of advertising and marketing agencies and consultants; (d) create, produce and implement websites; (e) provide other marketing-related services; and (f) pay all fees and expenses incurred in connection with the foregoing. For fiscal year 2013, franchise owners contributed $15.4 million to the Marketing Fund Trusts and the Company contributed $16.5 million to the Marketing Fund Trusts (comprised of $16 million of corporate contributions and $500,000 of collections from company-owned stores).
“Most of the Debtors and their non-Debtor subsidiaries exist to support the Debtors’ franchise system. QFA Royalties is the Debtors’ franchisor in the United States, and Quiznos Global is the Debtors’ international franchisor and enters into master franchise agreements with non-U.S. master franchisees, including in Canada. TQM currently licenses trademarks to the international master franchisees.
“Pursuant to various intercompany agreements, QFA Royalties has assigned or delegated certain of its rights and duties as the United States franchisor to its affiliates. Specifically, under a franchise servicing agreement between QFA Royalties and TQSC, TQSC is responsible for pre- and post-opening obligations under the Debtors’ franchise agreements for restaurants located in the United States and Puerto Rico, including: (a) managing the entities operating under QFA Royalties’ authority; (b) marketing and offering new and successor franchise agreements; (c) assisting the franchisees operating in the United States and Puerto Rico; (d) implementing and enforcing the Debtors’ quality assurance programs; and (e) otherwise fulfilling QFA Royalties’ duties under the franchise agreements. TQSC is paid by QFA Royalties for performing such services and may subcontract with its affiliates to provide such services. TQSC also acts as QFA Royalties’ franchise sales agent.
“Pursuant to the Issuer Products License Agreement, dated February 9, 2005, between QFA Royalties and AFD (the “Issuer Products License Agreement”), AFD or certain designated affiliates have the right to select the suppliers, manufacturers and distributors of food and non-food products for the Debtors’ franchisees in the United States and Puerto Rico. Further, under the Issuer Products License Agreement, AFD has a sublicense to use certain Quiznos IP (as defined below) in connection with the purchase and sale of proprietary products.
“In exercising its rights under the Issuer Products License Agreement, AFD provides franchise owners with food, restaurant supplies, and restaurant equipment procurement and logistical services from third-party vendors through third-party distribution centers. AFD arranges the procurement of propriety products by unaffiliated manufacturers and, in some cases, wholesales such products to distributors who will then sell such products to franchise owners. By leveraging its relationships with approximately 178 manufacturers and suppliers of food products, AFD is able to negotiate favorable pricing for its franchisees. AFD also conducts detailed benchmarking surveys to ensure that its aggregate prices are competitive and generally below those offered by independent distributors, which translates into reduced costs for franchisees and a strong price-to-value proposition for consumers.
“The following other Debtor and non-Debtor entities also serve an important role within the Debtors’ franchise system:
QIP holds all of the “Quiznos” marks, copyrights, confidential information and other intellectual property (collectively, the “Quiznos IP”) in the United States. QIP has licensed the Quiznos IP to QFA Royalties for a 99-year term to use in, among other things, exercising QFA Royalties’ rights and duties as the United States franchisor.
Restaurant Realty manages the Debtors’ lease assistance program in the United States. Historically, Restaurant Realty would enter into leases on behalf of the Debtors with third-party landlords for the purpose of sublease or assignment to franchisees. Following sublease or assignment, the franchisee pays rent directly to the landlord under the master lease. Since 2011, however, new franchisees generally enter into leases directly with third-party landlords. As of the Petition Date, Restaurant Realty remains the sublessor on approximately 49 subleases. Contemporaneous with the filing of the chapter 11 cases, the Debtors have filed a motion to reject certain of the leases with third-party landlords, specifically those leases for stores that have closed.
Quizmark, a non-Debtor, historically provided financing to certain franchisees who purchase all of the equipment, leasehold improvements and architectural services from the Debtors or a third-party for the purpose of (a) developing a new traditional restaurant, (b) reopening a traditional restaurant that previously closed, (c) buying a traditional restaurant from an existing franchisee for the purposes of transferring the franchise or (d) remodeling a traditional restaurant by an existing franchisee (the “Franchisee Financing”). Under the Franchisee Financing, Quizmark directly pays a franchisee’s vendors for the franchisee’s purchase of certain permitted equipment, leasehold improvements, and architectural services up to the financed amount. If Quizmark provides Franchisee Financing, the applicable franchisee executes a note, the terms of which vary.
QCE Gift Card, a non-Debtor, provides stored value card services to the franchisees.
Company Owned Restaurants
“The Debtors own and operate their proprietary restaurants through two subsidiaries – Quiz-DIA, a non-Debtor, and TQOC. As of the date hereof, (a) Quiz-DIA owns two non-branded restaurants—Chef Jimmy’s and Mesa Verde—and one “Quiznos”-branded restaurant at the Denver International Airport, and (b) TQOC owns three “Quiznos”-branded restaurants, two in Denver and one in Lakeville, Minnesota. In 2013, approximately $20.5 million in revenue was generated from the restaurants owned by Quiz-DIA and TQOC.
PREPETITION CAPITAL STRUCTURE
“As referenced above, as of the Petition Date the Debtors had (a) total principal outstanding indebtedness in an aggregate amount of approximately $618.5 million under the First Lien Credit Agreement (as defined below) and the Second Lien Credit Agreement (as defined below) and (b) total principal outstanding indebtedness of approximately $7.3 million under the Marketing Fund Trust Credit Agreement (as defined below).
First Lien Credit Facility
30. QCE is the borrower under that certain Amended and Restated Credit Agreement (the “First Lien Credit Agreement”) among QCE, as borrower, Holdco, the lenders party thereto, Goldman Sachs Credit Partners L.P. (“GSCP”), as Administrative Agent, Deutsche Bank Securities Inc., as Syndication Agent, and Credit Suisse Securities (USA) LLC, Wachovia Bank, N.A., and BNP Paribas Securities Corp., as Co-Documentation Agents (the “First Lien Credit Facility”). Pursuant to the Successor Agent Agreement and Third Amendment to Credit Agreement, dated as of December 18, 2013, Wilmington Trust, National Association (in its capacity as successor agent, the “First Lien Administrative Agent”) has succeeded GSCP as Administrative Agent under the First Lien Credit Agreement. All of the obligations under the First Lien Credit Agreement, including the guarantees of those obligations, are secured by substantially all of the assets of the Debtors (with the exception of the assets of QAFT and the Marketing Fund Trusts) and Quiz-DIA, which is not a Debtor. As of the date hereof, the total principal amount outstanding under the First Lien Credit Agreement is $444,695,086.92.
Second Lien Credit Facility
“QCE is also the borrower under that certain Credit Agreement (the “Second Lien Credit Agreement”), among QCE, as borrower, Holdco, the lenders party thereto (the “Second Lien Lenders”), and U.S. Bank National Association (“US Bank”), as Administrative Agent (the “Second Lien Administrative Agent”). The Second Lien Credit Agreement is guaranteed by the same guarantors under the First Lien Credit Agreement and is secured by a second lien on the same assets that secure the obligations under the First Lien Credit Agreement. As of the date hereof, the total principal amount outstanding under the Second Lien Credit Agreement is $173,828,686.23.
Intercreditor Agreement
“On January 24, 2012, QCE entered into an intercreditor agreement (as amended, restated, supplemented or otherwise modified from time to time, the “Intercreditor Agreement”), with GSCP (which has since been replaced as the First Lien Administrative Agent), as agent for the First Lien Credit Facility, and US Bank, as agent for the Second Lien Credit Facility, and certain other entities that may become party thereto from time to time. The Intercreditor Agreement, among other things, provides that the Second Lien Lenders have liens and security interests subordinate to the liens and security interests of the First Lien Lenders.
Marketing Trust Credit Facilities
“On September 26, 2007, the Marketing Fund Trusts entered into the Credit Agreement among QAFT, solely in its capacity as trustee for the Marketing Fund Trusts, as borrowers, the lenders party thereto, and Vectra, as administrative agent (as amended from time to time, the “Marketing Fund Trusts Credit Agreement”). The obligations under the Marketing Fund Trusts Credit Agreement are guaranteed by QCE. The maximum amount available under the Marketing Fund Trusts Credit Agreement was initially the lesser of $20 million and a borrowing base equal to 75% of the aggregate National and Regional Advertising Fees (as defined in the Marketing Fund Trusts Credit Agreement) for the most recent nine month calendar period. The obligations under the Marketing Fund Trusts Credit Agreement were originally set to mature on May 28, 2012.
“On January 31, 2013, QAFT entered into a fifth omnibus amendment and extension of the Marketing Fund Trusts Credit Agreement which reduced the maximum amount available under the Marketing Fund Trusts Credit Agreement to the lesser of (a) $10 million and (b) a borrowing base equal to 100% of the aggregate National and Regional Advertising Fees for the most recent six calendar month period commencing six months after the closing date of the fifth amendment. The obligations under the Marketing Fund Trusts Credit Agreement were set to mature on December 31, 2013. Pursuant to a forbearance agreement and series of amendments thereto, Vectra has agreed to forbear from exercising its remedies under the Marketing Fund Trusts Credit Agreement, and QAFT has paid down the outstanding principal of the loan, leaving an outstanding principal balance of $7,351,872.27.
CIRCUMSTANCES LEADING TO THESE CHAPTER 11 CASES
The 2006 Leveraged Buyout and Management Turnover
“In the Debtors’ early years, the Debtors’ success was attributed to a focus on providing premium, quality products and marketing those products through an extensive advertising campaign. However, in the years leading up to and following the 2006 Leveraged Buyout, the Debtors shifted their focus to expanding their franchising business by aggressively marketing and selling a large number of franchises with limited pre-qualification requirements. Specifically, in selecting franchisees, the Debtors conducted only a limited review of potential franchisees and imposed minimal restrictions with respect to the locations for the franchise stores. Although this aggressive and unfettered selection process led to significant growth of the Debtors’ store base, it also left the Debtors’ franchise business with a large number of single-unit franchisees who had little or no relevant experience and with stores often in undesirable locations. As a result, the Debtors began to experience poor operational performance and the “Quiznos” brand began to suffer. These issues were exacerbated by the turnover in the Debtors’ management following the 2006 Leveraged Buyout, which led to inconsistent marketing, failed strategic initiatives and customer confusion regarding the “Quiznos” brand.
“As a result, same store sales declined and average unit volumes (“AUV’s”) suffered, resulting in increased store closures and making it increasingly difficult to sell and open new locations. For example, in 2007, AUV’s declined by 6.1%, and approximately 450 stores closed, with only 225 new stores opened.
“The Debtors’ struggles were further compounded by the Debtors’ lack of necessary systems and infrastructure to monitor and analyze unit-level performance. As a result, royalty revenues (which typically constitute a percentage of franchisee revenues) and revenues from food sales suffered, with total revenues declining by 8.8% in 2007, compared to a 12% increase in revenues in 2006. Reduced food sale volumes, in turn, strained the Debtors’ ability to manage their supply and distribution channels effectively as the Debtors’ purchasing leverage and shipping efficiency decreased. Furthermore, the minimum volume and other threshold requirements in certain contracts and leases limited the Debtors’ ability to absorb these top line declines.
Economic Downturn, the 2012 Restructuring and Subsequent Management
Changes
“The Debtors also have been negatively impacted by the economic downturn in recent years. Specifically, high unemployment rates have significantly affected performance in the Debtors’ stores, which are primarily located in professional office plazas and higher-end retail malls,
which have suffered from reduced consumer traffic. Moreover, as the economy declined, the Debtors also began to face increased competition not only from the expansion of existing competitors but also from the new sandwich and fast casual market entrants. Some of these fast casual competitors have much larger store systems, greater marketing resources and/or other economies of scale. Other participants in the fast casual market also took advantage of the Debtors’ struggles by offering products similar to the Debtors’ signature toasted sandwich. The limited number of experienced, multi-unit store operators with significant financial resources further impacted the Debtors’ competitiveness during this period. As a result, from the end of 2007 through 2011, there were over 3,650 store closures, with net closures of over 2,200 stores. During the same period, the Debtors’ store base declined by over 40% and revenues decreased from $774 million in 2007 to $355 million in 2011.
“In January 2012, the Debtors underwent the 2012 Restructuring. The 2012 Restructuring reduced the debt and interest burden and provided new capital for the Debtors, which the Debtors intended to use to launch certain new initiatives and facilitate a long term turnaround of the Debtors’ business. Among the new initiatives were improvements to the Debtors’ menu and a re-launch of the “Quiznos” brand through increased marketing and advertising expenditures. These initiatives, however, proved inadequate to resolve the Debtors’ performance and financial problems. Specifically, the initiatives failed to improve the health of the franchisee base, as the initiatives did not mitigate store closure rates or facilitate sales and opening of new store locations. The 2012 Restructuring also failed to address certain of the Debtors’ problematic legacy contracts and other liabilities that were a drain on the Debtors’ business. In particular, certain contracts were based on volume commitments that were no longer achievable given the Debtors’ reduced store count or store-level volume, which require the Debtors to pay significant annual penalties for missed volume commitments. Finally, the Debtors believe that certain of the Debtors’ then-existing management engaged in conduct that was detrimental to the Debtors and, among other things, resulted in unrealistic expectations from the 2012 Restructuring.5 Ultimately, despite the 2012 Restructuring, store count continued to decline, with 416 net closures in 2012 (following 496 net closures in 2011), and revenues further declined from $355 million in 2011 to $299 million in 2012 (or -15.8% year- over-year).
“In 2012, I joined the Debtors as their CEO, and proceeded to replace most of the Debtors’ then-existing management team with the current senior management team. The Debtors subsequently pursued a number of operational initiatives in an effort to facilitate a turnaround of the Debtors’ business. Notwithstanding these initiatives, and their anticipated long- term benefits, however, the Debtors’ financial performance is unable to support the existing capital structure. The Debtors ended 2013 with revenues of $236 million (a 21% decline as compared to 2012) and with a store count of 2,099 (down from 2,577 in 2012). The Debtors now have limited liquidity and cannot meet their debt and contractual obligations. Accordingly, while the Debtors’ management team is confident in the Debtors’ planned turnaround initiatives, the success of the chapter 11 cases, and the new capital structure that will result therefrom, are integral to the implementation and success of these initiatives.
Investigation Regarding the 2012 Restructuring
“Over the course of approximately the past nine months, the Debtors, with the assistance of Akin Gump Strauss Hauer & Feld, LLP (proposed co-counsel to the Debtors), have conducted an investigation regarding alleged misconduct that occurred in connection with the 2012 Restructuring (the “Investigation”). The Investigation has revealed that in connection with the 2012
“Restructuring there appears to have been a concerted effort by certain former officers, managers and related parties of the Debtors (the “Specified Litigation Parties” (as that term is further defined in the Plan)) to deceive other members of the Debtors’ management, certain minority board members, and the Debtors’ then-existing lenders. As a result of this conduct, the Debtors and the Debtors’ then-existing lenders—in particular Avenue and Fortress—suffered material damage.
“Internal projections and related communications demonstrate that the financial projections created at the direction of the Specified Litigation Parties and provided to the Debtors’ then-existing lenders in connection with the 2012 Restructuring were not reasonable and gave the false impression that after the 2012 Restructuring the Debtors could service their debt obligations and sustain their new capital structure. Through these projections, the Specified Litigation Parties made it appear that following the 2012 Restructuring the Debtors could and would achieve results that lacked a reasonable factual basis.
“The conduct of the Specified Litigation Parties harmed the Debtors because the 2012 Restructuring left the Debtors with an unsustainable debt burden and a capital structure that significantly inhibited growth. In the months and years following the 2012 Restructuring, many of the Debtors’ key performance metrics came in below the projected amounts for fiscal years 2012 and 2013, including, but not limited to, total revenue, gross revenue, gross profit, royalty payments, store count, AUV growth, “SNO” count, and “SNO” terminations. As a result, the Debtors sustained losses in the form of lost opportunities, harm to their business and brand and other losses.
“The Debtors also believe that the conduct of the Specified Litigation Parties harmed Avenue and Fortress, as then-existing lenders, because the projections influenced their decision to support the 2012 Restructuring and invest in what was an unsustainable capital structure.
“Based on the foregoing, the Debtors believe that there are colorable claims against the Specified Litigation Parties (the “Specified Litigation Claims”) for, among other things, fraud and breach of fiduciary duty, and intend, jointly with Avenue and Fortress, to pursue legal action against the Specified Litigation Parties. Indeed, a key part of the Plan is an agreement among the Debtors, Avenue and Fortress (the “Specified Litigation Agreement”) to pursue these claims jointly. In connection with pursing the Specified Litigation Claims, the Debtors, Avenue and Fortress will seek to establish, among other things, that the Specified Litigation Parties (a) engaged in fraud and breached their fiduciary duties to the Debtors, which denied the Debtors the opportunity to pursue an alternative restructuring transaction that would have right-sized their capital structure and permitted the Debtors’ business to grow; (b) misrepresented and omitted material information from the documents provided in connection with the 2012 Restructuring, (c) provided parties in interest with fraudulent and misleading projections in connection with the 2012 Restructuring, (d) acted intentionally in doing so, (e) induced Avenue and Fortress to consummate the 2012
Restructuring based on inaccurate projections, information and documents, and (f) caused Avenue and Fortress substantial harm as a result of their conversion of first lien debt to second lien debt, conversion of substantial debt to equity and (solely with respect to Avenue) the infusion of $150 million into the Debtors. The forgoing should not, however, be viewed as limiting or restricting any claims that may be investigated and/or pursued in connection with the Specified Litigation Agreement and the subject matter thereof.
The Restructuring Support Agreement
“In the fall of 2013, the Debtors and their advisors commenced negotiations with certain significant lenders under the First Lien Credit Agreement (the “Consenting First Lien Lenders”), Avenue and Fortress, and their respective advisors, regarding the terms of a potential restructuring of the Debtors’ obligations under the First Lien Credit Agreement and Second Lien Credit Agreement.
“After months of intensive, good faith and arm’s length negotiations, the Debtors reached an agreement with the Consenting First Lien Lenders, Avenue and Fortress (collectively, the “Consenting Parties”) on the terms set forth in the Plan, and formalized by a restructuring support agreement (the “Restructuring Support Agreement”).
“As is required by the Restructuring Support Agreement, the Consenting First Lien Lenders have each submitted their votes in favor of the Plan. So long as the Restructuring Support Agreement remains in effect, the Debtors and the Consenting Parties have each agreed to use commercially reasonable efforts to support and consummate the Plan, the key terms of which are as follows:6
Holders of First Lien Facility Claims will (a) receive their Pro Rata share of (i) the $200 million Amended First Lien Credit Facility and (ii) 100% of the equity in Reorganized Holdco (the “New Common Interests”) issued as of the Effective Date, subject to dilution by any New Common Interests issued under the New Management Equity Incentive Plan and to Holders of Allowed Unsecured Claims that elect to receive (the “Stock in Lieu Election”) their Pro Rata share of 30% of the New Common Interests and (b) forego any distribution in respect of their First Lien Facility Deficiency Claims;
Holders of Unsecured Claims (including the Second Lien Facility Claims) against the Debtors will receive their Pro Rata share of the Company Specified Litigation Proceeds, unless such Holders make the Stock in Lieu Election. The Consenting Second Lien Lenders have committed to make the Stock in Lieu Election;
On account of Vectra’s Marketing Fund Trusts Facility Secured Claim, Reorganized QAFT, solely as trustee for the Reorganized Marketing Fund Trusts, and Vectra will This Plan overview is intended only to provide a summary of certain key terms, structure, classification and treatment provided under the Plan, and is qualified in its entirety by reference to the entire Plan and all exhibits related thereto. Capitalized terms used but not defined in this paragraph 48 shall have the meaning ascribed to such terms in the Plan, which has been filed concurrently herewith.enter into the Amended Marketing Fund Trusts Credit Agreement. Vectra will forgo any distribution in respect of their Marketing Fund Trusts Facility Guaranty Claim against QCE;
the Reorganized Debtors, Avenue and Fortress will enter into the Specified Litigation Agreement, which provides for, among other things, (a) the joint pursuit of the Specified Litigation Claims, to be funded by Avenue and Fortress, and (b) a sharing of the proceeds that may be recognized therefrom, pursuant to the Specified Litigation Waterfall7; and
the Reorganized Debtors and the Consenting First Lien Lenders will enter into the New Delayed-Draw Term Facility Agreement, pursuant to which the Consenting First Lien Lenders will provide the Reorganized Debtors with $25 million of availability to pay transaction expenses and provide the Reorganized Debtors with working capital necessary to run their business.
“The Debtors believe that Confirmation of the Plan consistent with the terms of the Restructuring Support Agreement will (a) allow the Debtors to emerge from chapter 11 appropriately capitalized and with access to favorable financing to support their emergence and go- forward business needs and (b) through the Specified Litigation Agreement, afford the Debtors (and their unsecured creditors) the opportunity to maximize the value of their recoveries on account of the Specified Litigation Claims.
DIP Credit Facility
”The Debtors will require additional liquidity to complete the Plan confirmation process and to implement the restructuring. Therefore, the Debtors have negotiated the terms of a debtor in possession loan (the “DIP Facility”) with the Consenting First Lien Lenders (the “DIP Lenders”). The DIP Facility will act as a bridge for the Debtors to implement and consummate the restructuring transactions contemplated in the Plan, and enable the continued operation of the Debtors’ business, avoid short-term liquidity concerns and preserve the value of the Debtors’ estates while in chapter 11.
“The Specified Litigation Waterfall provides: (i) the first $1,600,000 of Specified Litigation Proceeds to be distributed to the Reorganized Debtors for reimbursement of fees and expenses incurred by the Debtors prepetition in connection with the Specified Litigation (the “Legal Expense Reimbursement”); (ii) any Specified Litigation Proceeds available after payment of the Legal Expense Reimbursement to be used to reimburse Avenue and Fortress for payment of any actual out of pocket non-legal expenses (the “Non-Legal Expense Reimbursement”); (iii) the next $16,000,000 of Specified Litigation Proceeds available after payment of the Legal Expense Reimbursement and the Non-Legal Expense Reimbursement to be distributed 75% to Avenue and Fortress and 25% to the Reorganized Debtors (the “First Round Specified Litigation Proceeds Distribution”); and (iv) any Specified Litigation Proceeds available after payment of the Legal Expense Reimbursement, the Non-Legal Expense Reimbursement and the First Round Specified Litigation Proceeds Distribution to be distributed 95% to the Avenue and Fortress and 5% to the Reorganized Debtors (the “Second Round Specified Litigation Proceeds Distribution”).
“The availability under the DIP Facility should provide comfort to the Debtors’ vendors, customers and franchisees that the Debtors will have sufficient liquidity to continue to operate in the ordinary course. The DIP Facility provides the Debtors with up to $15 million of new financing (the “DIP Loan”). The salient terms of the DIP Facility are as follows:
the DIP Loan is a $15 million delayed-draw term loan, of which up to $10 million principal amount will be available to be drawn upon entry of the interim order approving the Debtors’ entry into the DIP Facility and an additional $5 million will be available to be drawn following the entry of the final order approving the Debtors’ entry into the DIP Facility;
the DIP Loan will bear interest at 15% per annum. During the continuance of an event of default, the DIP Loan will bear interest at an additional 2% per annum;
The DIP Loan will be due and payable no later than 120 days from the date on which funds are first available for borrowing under the DIP Facility;
The proceeds of the DIP Loan will be used (a) to pay all (i) fees due to the DIP Lenders as provided under the DIP Facility and (ii) administrative costs of the chapter 11 cases and prepetition claims or amounts approved by the Bankruptcy Court; (b) to provide working capital for the Debtors, including postpetition ordinary course operating expenses; and (c) for other general corporate purposes of the Debtors.
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