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Eileen Appelbaum

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No Happy Ending for Friendly's

Posted: 11/21/11 11:35 AM ET

Three years after being taken private by an affiliate of private equity firm Sun Capital Partners, Friendly's -- the family restaurant and ice cream chain known for its Happy Ending sundaes -- filed for Chapter 11 bankruptcy protection. According to the filing, Friendly's proposes to use the bankruptcy to jettison the pensions of nearly 6,000 employees and retirees. Outrageous as this seems, Friendly's also proposes to sell itself out of bankruptcy to another affiliate of its current Sun Capital owners in an auction to be held in early December. While other bidders may enter the auction for Friendly's assets and frustrate these plans, the conditions proposed for the auction heavily favor Sun Capital's 'stalking horse' bidder.

A key part of Sun Capital's restructuring plan is to shift liability for the pension plan to the federal government's Pension Benefit Guaranty Corporation (PBGC). According to PBGC's exposure report, released earlier this week, assuming that plans are not terminated by healthy companies, the program can meet its obligations through the next 10 years although it faces a long-term deficit of $24 billion. Generally, businesses are able to shed pension liabilities in asset sales, and PBGC does not require companies to make good on pension plans they can no longer afford. But in an unusual move, PBGC announced that it will fight Sun Capital's attempt to stick US taxpayers with the bill. PBGC objects to what appears to be a transparent effort by Sun Capital to take advantage of the bankruptcy process to abandon pension obligations while continuing to keep its ownership of Friendly's. If Sun Capital gets away with this, PBGC will be on the hook for the pension payments, the program's finances will worsen, and Friendly's workers may not get the full pension benefit they are owed.

Sun Capital's disregard for Friendly's workers extends beyond this effort to dump its pension obligations. The company could have provided advance notice of the impending shutdown to workers at the 63 restaurants slated to close as part of the bankruptcy filing since the bankruptcy was clearly planned well in advance. Instead, workers at these stores were told one evening that the next day would be their last. About 1,260 employees, well over 10 percent of the company's workforce of 10,300, were laid off. The WARN Act requires 90-days advance notice of a mass layoff, but only if the company has 50 or more full-time employees at a particular site. Most Friendly's stores have about 20 employees. New York has its own state WARN Act which applies to firms with 25 or more workers at a single location. It is possible that some of the six closed Friendly's restaurants in New York are vulnerable to a WARN Act violation. Even if Sun Capital is not legally prohibited from laying these workers off without 90 days' notice, common decency suggests they deserved more than the 24 hours' notice they got.

Friendly's blames its financial woes on the recession and the rising price of cream. These are real issues, but according to Restaurant Finance Monitor, "Friendly's problems are largely of its own making." The leveraged buyout left Friendly's with $297 million in debt, most of it taken out in 2008. In addition, after acquiring Friendly's, Sun Capital sold its corporate headquarters property and the buildings housing160 of its restaurants in a sale-leaseback arrangement in which the restaurants paid above market rents to stay in the same buildings that the chain used to own. Under these circumstances, Friendly's could not make the investments and operational changes to make the turn around that Sun Capital had promised. As for the private equity firm's claim to improve governance, Friendly's had 2 CEO's in its 3 years as a Sun Capital portfolio firm.

This is not the first time a Sun Capital portfolio firm was burdened with debt, saddled with above market rents in a sale-leaseback agreement for its facilities, and refused an injection of cash from the private equity firm that could have helped it survive. The bankruptcy of the west coast department store chain, Mervyn's, while in Sun Capital's hands not only cost the jobs of 30,000 workers, but stiffed the vendors for merchandise valued at $102 million.

Private equity firms argue that restructuring may be painful, but the improved financial, governance, and business operations at affiliated portfolio companies creates economic value. Sun Capital might have a hard time making this case. SSI Group, which operates Grandy's and Souper Salad restaurants, and Real Mex, which operates El Torito Restaurant and Chevys Fresh Mex -- all Sun Capital portfolio companies -- also entered bankruptcy in the past two months.